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What Is an Employee Deferral?

By G. Wiesen
Updated May 16, 2024
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An employee deferral is an investment, often into a retirement account that pays into a mutual fund, that is based on personal income. Rather than receiving this payment at the regular time in which someone receives his or her salary, it is invested into an account before taxes are taken on it. Once in the account, this money can begin making interest and is often used as a retirement program after many years of investing. The taxes on the money deposited into the account are taken once the investment is finally paid out to an individual, which is the end of the employee deferral.

Taxes that are typically paid on income are the source of the name "employee deferral," as these are paid at a later date. Someone typically sets up this type of plan with his or her employer, who pays money into an investment account rather than to the employee. A certain percentage of the employee's salary is paid in before taxes are taken on it, though other benefits for income such as unemployment or social security do include this invested amount. Different types of investments can be used with an employee deferral, though mutual funds are quite common.

Once the investment reaches a certain level of maturity, frequently after several decades of additions and growth, then the returns and capital can be paid out on the employee deferral. This is what makes these types of plans so popular for retirement, as they build interest and grow over many years. Once this payout is received, however, then the income tax on the initial invested amount has to be paid. These taxes are the subject of the employee deferral, and with enough return on the investment, this can be offset by the revenue from the account over time.

Some companies offer to match an employee deferral for their associates, though this is typically provided to managers and officers within a corporation. There is usually a limit on the amount that a company is willing to match, though it can effectively double the return on this type of investment. Taxes may need to be paid on this matched amount, but it is commonly paid at a different rate since this investment is not actually payment made as income. This type of employee deferral matching by a company often makes certain employers more attractive than others. Like any other investment, the effectiveness of this form of retirement program depends upon the performance of the fund into which it is paid.

SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
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