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What Is Deferred Compensation

Posted by Daniel Nase, MBA

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Jul 18, 2014 2:10:58 AM



What Is Deferred Compensation?

These days it can be hard to save up money, so one way to do it is through a method that forces you to save even before you get paid. This type sabings is called deferred compensation. Deferred comp comes in several types, but basically it is an agreement between a company and an employee where part of their pay is deferred and will be paid out at a future date.


Common Types Of Deferred Compensation

One of the most common types of is a retirement plan. This is usually part of an employee’s benefits in their job that keeps adding up and is a form of investment or IRA in some cases. It would go to the employee when they either retire from the positon, or it usually can be transferred to a new job if it is an IRA. The value of a retirement plan type depends on how much money is held back from the person’s pay and what is done with it afterwards.

Some companies participate in programs where the employee agrees on a certain percentage of their pay being invested by the employer. The advantage of this is that the money is taken from the person’s pay prior to being taxed, so they save on it while it is in the investment program and don’t pay taxes on it until they draw it out at a future date.

Types Of Retirement Plans

There are several possible types of retirement plans that could be considered as deferred comp plans. These include:

401(k) Plan

The most common type of deferred pay used for retirement purposes is a 401(k). In some cases, the company will match the contributions of the employer in these plans, which let the employee save pre-tax dollars from their salary to provide for their retirement at a later date.

457 Plan

This type is used as a retirement plan and is available for federal and state employees. It is somewhat like a 401(k) plan, but the person’s employer doesn’t match the person’s monetary contributions. Otherwise it is the same as most 401 (k) plans.

409a Plan

This type can be used by some teachers. It is a way to allow them to get paid the entire year instead of just during the school year. This means they divide up their salary into equal portions over a 12 month period, instead of the nine months of a school year. While it isn’t a retirement plan, it is still a form of deferred comp.

Stocks And Bonds

Another method could be a company offering their employees stock options in the company. In this scenario the employer gets stock in lieu of a monetary amount. It helps both the company and the employee since the employer doesn’t have to pay cash to the person and the employee can get more than the stock is originally worth if the company does well by the time the person cashes in his stock options.

In this type an employee usually receives lower pay in return for an expected payout of the stocks and bonds profit at a later date. This type of deferred payment is common in new or startup companies that don’t have a lot of cash to payout to their employees in the beginning when they are just starting their company.

Of course, it is a bit risky to accept this kind of deferred pay because it is always possible that the company could go down in value and the stock options would then be worth less than their original value.

Profit Sharing

Profit sharing is a method where the business shares some of their pre-tax profits with their workers. This can be arranged in several ways, as it all depends on the company structure and the decisions made by the people involved. These are also called inventive plans. In this case the employee will have a vested interest in the increase of the profits because that means the employer will end up with more money in his portion of the deferred earnings this results in.

Profit gained from profit sharing types of deferred pay can come in the form of several things such as cash, stocks, bonds or a combination of these. Whichever type of way it is paid out, the profits are held in a trust and can be used to fund something like a retirement account. There are several advantages to this kind of deferred pay as it is pre-tax, so the person won’t be required to pay taxes on the deferred amount until it is paid out at a future date.

Profit sharing is a common way to pay out on a retirement plan for employees. If the company is doing well, it can bring the employees some excellent profits, but if not, they could also lose on their future amount of money being paid out when they retire.

It also takes a bit of time to set up a profit sharing agreement so research should be done to ensure the best possible plan is enacted.

Employee Bonuses

Another possible method of using deferred compensation is through the use of employee bonuses. Some companies give out employee bonuses for various reasons such as exemplary performance, or merely if the company does well and then every employee would get a percentage of the company profits at the end of the year. Some places also give bonuses such as holiday bonuses for employees to have extra cash to spend on holiday presents or vacations.

Some experts don’t consider employee bonuses to be a form of deferred compensation, but since it is paid out at a later date, it can fit into this category. While it doesn’t have the advantages of being paid out pre-tax, and the employee likely has to pay taxes on their bonus, it can still be a lucrative form of extra benefit to a person’s regular salary.

Topics: Deferred Compensation

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