What is deferred compensation and how does it function?

In a deferred compensation plan, a portion of an employee's compensation is set aside to be paid out at a later date, typically upon retirement. Both the employer and the employee agree on the terms, including the amount to be deferred, the payout schedule, and any conditions or restrictions. Deferred compensation plans offer various benefits, including tax advantages, retirement savings, and the ability to defer income to a lower tax bracket.

Qualified vs. Non-Qualified Deferred Compensation Plans:

Deferred compensation plans are often categorized as either qualified or non-qualified. Qualified plans, such as 401(k) plans, are subject to specific legal and regulatory requirements, including contribution limits, vesting requirements, and distribution rules. Contributions to qualified plans are made pre-tax, offering tax benefits for both employers and employees. Non-qualified plans, on the other hand, are more flexible but are not subject to the same regulatory requirements. They are typically offered to highly compensated employees and may provide additional retirement benefits beyond qualified plans.

Types of Deferred Compensation Plans:

401(k) Plans: Allow employees to contribute a portion of their salary on a pre-tax basis, providing immediate tax savings. Excess Benefit Plans: Non-qualified plans that allow high earners to defer income above the limit set by qualified retirement plans. Supplemental Executive Retirement Plans (SERPs): Non-qualified plans where companies contribute funds into a supplemental retirement fund for employees. Stock Option Plans: Allow employees to purchase company stock at a specific price in the future, providing a financial incentive for company success. Phantom Stock Plans: Give employees the right to receive a cash payment equal to the increase in the value of the company's stock over a certain period. Restricted Stock Units (RSUs): Employees receive company stock at a future date, subject to vesting requirements. Cash Balance Plans: Hybrid retirement plans that combine features of defined benefit and contribution plans. Bonus Deferral Plans: Allow employees to defer bonuses until a future date, deferring tax on the bonus until received.

Considerations:

While deferred compensation plans offer benefits such as tax advantages and retirement savings, they also come with considerations such as regulatory requirements, administrative complexities, and risks associated with non-qualified plans. Employers and employees should carefully evaluate the options available and consider consulting with financial and legal professionals when implementing deferred compensation arrangements.