What Is Deferred Compensation?
Deferred compensation is a compensation plan where the employer makes a contribution to the employee’s retirement plan, such as 401(k) or an IRA, and the employee defers the benefit until a later date.
Deferred compensation is common for employees in management positions, who often receive large deferred compensation packages. This type of compensation plan allows for immediate tax deferral.
Deferred compensation plans give companies a way to reward employees for their hard work. It also allows businesses to provide incentives for long term employees or those who will be away from an employer for a long period of time.
The employee agrees to go without a portion of the compensation in exchange for the right to receive it at a later time. Employers may match employee contributions.
Types of deferred compensation:
1. NDCP, Nonqualified Deferred Compensation Plans – when the employee gets paid on a pre-specified date in the future for the work he/she has done in the present. The payment usually happens at the time of termination of employment, death or disability.
2. Qualifying Deferred Compensation – includes plans for public education employers, non-government organizations, non-profit organizations, state and local government organizations.
Deferred compensation examples
1. Retirement plan – what is given to the employee once he/she retires from their services with the company
2. Pension – what is paid once an employee retires
3. Employee stock option – what is given to employees as a part of their compensation
All these examples deduct a proportionate monthly/quarterly/yearly premium from the employee’s income which is not covered under tax-deductible income for the current month/quarter/year.
What Is a Qualified Deferred Compensation Plan?
Qualified Deferred Compensation Plans (QDCPs) allow business owners to establish tax-advantaged retirement plans that offer a deferral feature that will allow the business owner to make contributions that will not be taxed while the business owner is accumulating assets in his or her account.
The employer will make contributions to the plan on a pre-tax basis, and the contributions will be invested in the pooled portfolio of assets held by the QDCP. The assets are invested in assets that generally will provide a higher rate of return than would be available in a non-qualified plan. In addition, the business owner has the ability to withdraw his or her contributions, and gains, on a tax-free basis.
What Is a Non-Qualified Deferred Compensation Plan?
A non-qualified deferred compensation plan (NQDPC) is a type of plan that defers both compensation and any benefits. NQDPC plans allow companies to:
1. Maintain flexibility in funding, without giving up the ability to contribute to a tax-deferred retirement plan;
2. Provide employees with allowances for benefit plans; and
3. Provide higher annual maximum amounts than qualified plans.
NQDPC plans are also referred to as 403(b) plans, 401(a) plans, deferred compensation.