Deferred Compensation

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Employees work and receive compensation in exchange for their services. “To defer” means to postpone or suspend. But how does it apply to compensation? Let us find out how. 

What is “deferred compensation?”

Deferred compensation refers to an arrangement wherein an employee is allowed to postpone being paid a certain portion of their compensation and get it at a later date. Meaning: a part of an employee’s compensation is set aside to be paid out in the future. You can also think about it as compensation that you have worked for and earned, but have not yet received from your company. 

By choosing to defer compensation, it reduces the employee’s taxable income for the current year. Why? This is because deferred compensation is not considered as taxable income until it is paid out or given to the employee. 

What is the purpose of deferred compensation? 

While there can be several reasons why organizations offer deferred compensation to employees, its purpose is typically for retirement plans and pension plans. Also, deferred compensation allows the employee to have potential advantages when it comes to tax. Because deferred compensation remains untaxed until the time of withdrawal (which is typically after retirement), the employee’s tax liability can be reduced. This is especially beneficial if the employee expects to be in a lower income tax bracket after they retire. 

It is important to note that deferred compensation always occurs with the employee’s consent. The decision to defer compensation primarily depends on the individual’s financial goals and personal tax decisions. 

What are the types of deferred compensation plans? 

Deferred compensation can be qualified or non-qualified. Let’s take a look at each one. 

Qualified deferred compensation plan

Non-qualified Deferred Compensation Plan

What are different forms of non-qualified deferred compensation plans? 

There are different forms of non-qualified deferred compensation plans or 409(a) plans which the Internal Revenue Service (IRS) recognizes: 

 

 

 

 

I am an employee. Should I consider a deferred compensation plan? 

It is always a good thing to plan and prepare for the future. There are a lot of things to consider before deciding to have a deferred compensation plan. Ask yourself some important questions. Are you planning on staying with your company until you retire? Is your organization financially stable? What types of deferred compensation plans are available to you? How comfortable are you in not taking home a portion of your compensation? Can you give that up? What are your financial goals? These are just some sample questions to keep in mind before deciding if a deferred compensation plan can benefit you.

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