Deferred Compensation Plans
Deferred compensation plans can offer an additional choice for employees when it comes to retirement planning and are a great incentive that employers use to hold onto key employees.
These plans are often used to supplement participation in a company 401(k) plan. Deferred compensation plans require an employee to defer receiving a part of his or her compensation until a specified future date and help reduce their personal tax burden, depending on the type of plan.
For example, an employee, age 55, and earning $250,000 a year, could choose to defer $30,000 of their annual compensation per year over the course of the next 10 years until they reach the age of 65 and retire.
A Qualified deferred compensation plan must be offered to all employees whereas a non-qualified deferred compensation plan can be offered to just key employees and used as a “golden handcuff”.
The deferred compensation funds are then set aside and can earn a return on investment until they are designated for distribution, or paid out, to that employee. At that time, the employee pays Social Security and Medicare taxes on the full deferred income amount, but they do not have to pay income tax on the deferred compensation until they actually receive the funds.