How does deferred compensation work?

Deferred compensation allows employees to request that a portion of their salary or bonus be set aside to be paid at a later date. The employer holds this amount, often investing it to help it grow over time. To set it up, employees can enter into a written agreement with their employer—often before the compensation is earned—outlining the deferral amount, payout schedule, and conditions for distribution.

What are the benefits of deferred compensation plans for employees?

Deferred compensation plans enable employees to reduce their taxable wages, thereby lowering their net payfor the current year. Since taxes are based on taxable wages, employees pay less in taxes now. The deferred money is taxed later, typically at retirement, which can be advantageous if the individual is in a lower tax bracket at that time.

What types of deferred compensation plans exist?

Deferred compensation plans are broadly categorized into qualified and non-qualified plans. Qualified plans, such as 401(k)s, follow set rules and offer tax advantages and creditor protection. Non-qualified plans are more flexible in design but are not subject to the same regulatory protections, as the deferred funds remain with the employer until they are paid out.