Deferred Compensation

Reviewed by Sujaini | Updated on Aug 27, 2020

What Is Deferred Compensation?

Deferred compensation is a part of an employee's salary, which is set aside for later payment. Taxes on the profit are postponed in most situations before it is paid out. Deferred compensation forms include insurance schemes, contingency plans, and stock option plans.

An employee can opt for deferred compensation, as it provides potential tax benefits. In most cases, income tax is delayed before payment of the bonus, usually when the employee retires. When, upon retirement, the employee wishes to be in a lower tax bracket than when the salary was received initially, they would have a chance to reduce their tax burden.

Types of Deferred Compensation

Deferred compensation has two broad categories: eligible and unqualified. These vary significantly in their legal care, and the role they serve from an employer's perspective. Deferred compensation is sometimes used to refer to unskilled plans, but the word technically encompasses both.

Deferred compensation allows more retirement money to be stashed away by the most valuable workers than is permitted for rank-and-file pension plans. Like the plans of 401(k) and the like in the U.S., deferred compensation funds are shielded off income tax. The money will grow tax-free before it is cashed out at retirement and by that point, borrowers would be in lower tax brackets. No wonder deferred executive compensation is standard.

Employees finance their paychecks by deductions, and they will also receive their bonuses. Employers tend to have a fixed return on investments or to invest the money in the employee's preferred fund.

Under the restricted bonus plans, the primary employee receives what is known as a life insurance policy with cash value. The employer pays the premiums in life insurance. The employee is entitled to an insurance benefit bonus, but only after he or she has been with the company for several years.