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What is Deferred Compensation?
Deferred compensation is an agreement between an employer and an employee in which a portion of their earnings, or compensation for work performed, is held back, or deferred, for payment at a future time. It is widely used as a retirement savings plan. An employer may offer a retirement plan to their employees as part of their compensation package, which might also include health insurance as well as actual wages. Although the value of the retirement is not specified in the hourly or yearly rate of pay, it is in fact deferred compensation that will be provided to the employee at some agreed upon rate and time.
Some employers participate in a deferred compensation program that allows a person to have a portion of their hourly or yearly wages invested by their employer rather than received as monetary compensation for work at the time that it is performed. There are a number of advantages to this.
One advantage to deferred compensation is that the portion of their compensation that is invested rather than disbursed to the employee is not subject to federal or state income taxes at the time it is earned. This is usually the time when a person’s income, and consequently their income tax liability are greater. It only becomes subject to federal and state income taxes when it is received by the employee much later.
In most cases the employee does not request disbursement of the deferred compensation until after they retire. At this point in time their income and the resulting tax liability is usually less. In addition, neither interest nor dividends earned from the deferred pay are subject to federal or state income taxes until such time that they are received by the employee.
In addition to deferred compensation used for retirement purposes, companies sometimes offer employees stock options. This is when the employee is issued the companies own stock as a form of non-cash compensation. This can be beneficial to both the employee and the company. The employee will benefit if the price of the stock is higher when it is cashed in than when it was earned. In turn the company will benefit as it gives the employee an incentive to perform their job with the company’s best interest in mind. The down side to this type of deferred compensation is when the price of the stock is less when it is sold than when it was earned.
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![Deferred compensation disbursements are generally not requested by the employee until after she or he retires.]()
By: Christopher MederDeferred compensation disbursements are generally not requested by the employee until after she or he retires. -
![In addition to deferred compensation used for retirement purposes, companies sometimes offer employees stock options.]()
By: AlterfalterIn addition to deferred compensation used for retirement purposes, companies sometimes offer employees stock options.
Discussion Comments
Has anyone gotten to retirement age and started to benefit from their deferred compensation plan? How does it hold up in comparison to regular government pension plans and registered retirement savings?
I am just starting out as a saver and would like to make some good solid investments that will keep me comfortable after I retire. I am worried that if I choose the wrong plan I will be too heavily taxed, or may not garner as much interest as I would like. My goals are not too outlandish, just enough income for necessities and to keep my home in working order. I plan to be mortgage free long before I retire so I don’t have to worry about that.
I think going with deferred compensation is more risky these days with the number of large businesses that have been going under. The fact is if a company declares bankruptcy the creditors can and will go after any funds in deferred compensation plans putting the employees out in the cold.
There is very little protection for money in deferred compensation accounts and often somewhere in the literature you signed there will be a clause that if they lose the money due to bankruptcy, it's too bad for you.
If you feel your company is going under the best thing you can do is flee with your money intact, even if you have to pay taxes on the amount withdrawn.
Receiving stock options from the company you work for can be a good way to provide extra money for retirement. It is, however, a little bit more risky than other compensations. When it is sold in retirement, because of fluctuations in the stock market, the selling price could be a lot lower than when it was issued to you. Or, if luck is on your side, it could provide substantial amounts. This type of deferred compensation is good to have, but you can't count on it.
Either way - whether a deferred compensation is taxed at the time of issue or whether it is taxed at the time it is withdrawn in retirement, it is beneficial to the employee. So many Americans are not very motivated to save. They tend to spend most of what they get in their paycheck. Deferred compensation helps them save for their needs in retirement.
@Subway11 - That is a good idea. I have a friend that works for the city of New York and she has a deferred compensation plan too. She has a 457 deferred compensation plan and it works like a 401K but it is a little different.
She is able to put in up to $16,500 in either a regular 457 deferred compensation plan or a Roth 457 deferred compensation plan. The difference is that with a Roth her contributions are taxed now and when she withdraws her money it will not be, but with the regular 457 deferred compensation plan, her contributions are pre taxed and she has the opportunity to withdrawal money from this account before the age of 59 and a half.
With the Roth 457 deferred compensation plan there is a penalty for withdrawals made before age 59 and a half, but the earnings grow tax free and when it is time to withdraw funds you no longer owe any taxes on the money. This is why a lot of people really like the Roth plan.
At my husband’s company they have a non qualified deferred compensation plan. It is a retirement plan that allows executives of the company to place earnings into this fund but the earnings are not yet counted by the company.
This allows the earnings to grow tax free until retirement. It is a way to set aside more money for retirement outside of a 401K. The limits are really high too. You can put up to $45,000 a year into one of these accounts. If you could use less of your salary it is a good tool to use for retirement savings.
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