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Deferred compensation

Deferred compensation is a money term you need to understand. Here’s what it means.

What is deferred compensation?

Deferred compensation is a strategy whereby an employee sets aside income for pay at a later date.

You should also note that if your company files for bankruptcy, any funds in a non-qualified deferred compensation plan are not protected from creditors.

Deeper definition

A deferred compensation plan allows employees to place income into a retirement account where it sits untaxed until they withdraw the funds. After withdrawal, the funds become subject to taxes, although this is usually much less if payment is deferred until retirement.

Deferred compensation example

Examples of deferred compensation include retirement, pension, deferred savings and stock-option plans offered by employers. In many cases, you do not pay any taxes on the deferred income until you receive it as payment.

Deferred compensation plans come in two types — qualified and non-qualified. Qualified retirement plans such as 401(k), 403(b) and 457 plans, are offered to all employees and are taxed when the contribution is made to the account.

Also called 409(a) plans, non-qualified deferred compensation plans are offered to executives and key employees. There are no limits on contributions, and these plans allows the company to postpone payment of some pay while giving the recipient a way to save more for retirement that a qualified plan.

Also aimed at key executives, another type of deferred compensation plan is the supplemental executive retirement plan. A SERP mirrors defined-benefit plans in that they guarantee a set amount at sign-up that you receive at retirement.

Some of the more common ways of calculating the amount of a SERP include a flat dollar amount for an agreed upon number of years, a percentage of your salary times the number of years at retirement or a percentage of salary to a certain number of year.

The plan can even be structured for funding by a cash value life insurance policy to pay out to your beneficiaries in case you die prematurely.

Do you know whether your retirement savings will last through your retirement? Use this calculator to find out.

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