Deferred Compensation

Deferred Compensation is a financial arrangement in which a portion of an employee’s earnings is withheld and paid out at a later date, typically after retirement or upon leaving the company. It’s often used as a retirement planning tool or executive incentive, offering tax advantages and long-term financial security.

There are two main types:

• Qualified deferred compensation (for example, 401(k), 403(b)) - regulated by ERISA and provides tax benefits and protections
• Non-qualified deferred compensation (NQDC) - often used for highly compensated employees or executives with custom payout agreements

Key Facts

• Payment Is Delayed: Instead of receiving income immediately, a portion is set aside for future payout, often over years or at retirement.
• Used for Executive Retention: Non-qualified plans are often structured to retain top talent, offering incentives to stay until retirement or a future milestone.
• Tax Benefits: For qualified plans, contributions are pre-tax, reducing taxable income now. Taxes are deferred until funds are distributed, often at a lower tax rate during retirement.
• Two Main Types:
  
  • Qualified Plans: Includes 401(k), 403(b), and 457(b) plans, subject to contribution limits and IRS rules, offers ERISA protection
  • Non-Qualified Plans (NQDC): Custom agreements (such as Supplemental Executive Retirement Plans), no IRS contribution limits, more flexible, but less secure (subject to employer solvency)
• Vesting May Apply: Some deferred compensation plans include vesting schedules, meaning the employee must stay with the company a certain time to earn the full benefit.
• Risks with Non-Qualified Plans: These funds are not protected from company creditors and may be lost if the company goes bankrupt.

1. What is deferred compensation?

It’s a portion of your earnings that is paid out in the future, often used for retirement planning or executive pay packages.

2. How does deferred compensation affect my taxes?

• Qualified Plans: Contributions are tax-deferred, and taxes are paid upon withdrawal.
• Non-Qualified Plans: Taxes are typically deferred until payout, but contributions are not tax-deductible for employers.

3. What’s the difference between qualified and non-qualified deferred compensation?

• Qualified: IRS-regulated, tax-advantaged, includes 401(k), 403(b), or other.
• Non-Qualified: Custom agreements, no IRS limits, but riskier and often used for executives.

4. Can I lose money in a deferred compensation plan?

Qualified plans are relatively safe and protected under ERISA, while non-qualified plans carry risk - if the company goes bankrupt, the deferred funds may be unrecoverable.

5. Why would someone choose deferred compensation?

To lower current tax liability, build retirement savings, or take advantage of employer matching or investment growth.