What Is Deferred Compensation?

Deferred Compensation

Deferred compensation is a piece of the earnings puzzle that's frequently set aside to be collected at a later date. This strategy often occurs during retirement, providing timely tax benefits. The gist of it is simple: defer the taxes due until the compensation is paid out.

Types of Deferred Compensation Plans

Qualified Deferred Compensation

Primarily made up of 457b retirement plans, these are designed specifically for state and municipal workers as well as employees of some tax-exempt organizations. We're focusing on governmental 457b retirement plans. An intriguing variant in this category is the Roth 401k. It’s a bit different, requiring employees to pay taxes on income as it’s earned. The silver lining? The balance in a Roth account is tax-free when withdrawn.

Non-Qualified Deferred Compensation

Dominating the scene among high earners and executives, non-qualified plans bring a different flavor. The amount deferred, distribution timing, and employer’s purpose truly matter here. There's no IRS cap on the contribution each year, thus maximizing the savings potential. Employees and their employers contractually agree to the terms of the deferral with certain requirements or exclusions. However, they are not protected by the Employee Retirement Income Security Act (ERISA). Due diligence in weighing the risks before enrolling is highly advised, as losing the entire balance if the employer goes bankrupt is always a looming risk.

Deferred compensation vs. 401(k)

When it comes to retirement planning, Deferred Compensation and 401(k) are two popular strategies. Yet, they've got distinct characteristics that set them apart. A 401(k) plan refers to a tax-advantaged retirement savings plan primarily offered by employers, with employee's contributions often being matched to a certain degree.

On the flip side, Deferred Compensation is a plan where a portion of an employee's income is paid out at a later date, typically after retirement. This strategy is often leveraged by high-income earners aiming to defer taxes on their earnings. The decision to opt for one over the other depends on factors such as income level, job security, and retirement objectives.

  • Deferred Compensation: Provides tax-deferral benefits.
  • 401(k): Employer-matched contributions, tax advantages.

Why should HR leaders implement deferred compensation?

Boosts Employee Loyalty

People value a future-focused employer. By offering Deferred Compensation plans, you're not merely providing a benefit but demonstrating a long-term commitment to their financial health. That commitment isn't forgotten: it fosters deep-seated employee loyalty.

Promotes Employee Retention

Employees are significantly more likely to stay with a company that helps them grow their nest egg. Deferred compensation plans allow employees to invest more in their future, making them think twice before jumping ship. It's not just a perk; it's an effective retention strategy.

Attract New Hires

Competing for talent isn't just about salary. People are looking for organizations that care about their future. Offering deferred compensation is a clear signal to prospective employees that you're that organization. It's a drawcard few top talents can resist.

Improve Company Culture

Beyond financial benefits, deferred compensation programs cultivate a culture of stability and growth. They say to your team: "We're planning for the long haul, and we want you with us." That future focus isn't just good for the bottom line – it helps build a positive corporate culture.