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What is deferred compensation?

Attracting and retaining key employees is key to the long-term success of any business. There are many strategies to achieve this, such as offering competitive salaries and strong benefits. Another strategy that businesses use is to offer a deferred compensation plan to certain employees. Continue reading for more information on what deferred compensation is.

What is deferred compensation?

Deferred compensation refers a portion of an employee’s wages that are set aside to be paid at a later date. This distribution date, which may be at retirement or after a specified number of years, must be designated at the time the plan is set up and cannot be changed. Retirement plans, pension plans, and stock-option plans are a few examples of deferred compensation.

There are two main categories of these types of plans.

Qualified Deferred Compensation Plans

Certain qualified plans, such as 401(k), 403(b) and 457 retirement plans, are offered to all employees and are taxed when the contribution is made to the account. There are contribution limits to these types of accounts. Additionally, these plans are safe from creditors should the company go bankrupt.

Non-Qualifying Deferred Compensation Plans

Non-qualifying plans differ from qualified plans as they do not have to be offered to all employees of the company and have no limits on contribution amounts. The money in these types of plans is not taxed until the money is withdrawn from the account. These types of plans provide employers with a way to attract and hold on to valuable employees. However, non-qualifying plans are a bit riskier as the compensation is not protected from creditors should the company file bankruptcy.

What are the benefits of deferred compensation plans?

There are a handful of benefits of these types of plans. First, there are no contribution limits on non-qualifying plans. Employees, especially high earning employees, who want to save more for retirement can contribute as much of their income as they would like. Secondly, like 401(k) plans or IRAs, the money in these plans grows tax-deferred. The big advantage here is if an employee retires in a lower tax bracket than they are currently in, or a state that does not require income tax, there can be significant tax savings in the future. Finally, tax deductions can be taken for the period that the contributions are made.