In order to entice and retain top talent, many employers go above and above by providing a generous benefits package. An example of such a benefit is a deferred compensation plan; being familiar with its ins and outs is crucial because of the potential long-term benefits they offer. This page defines deferred compensation, explains how it works, lists the many types of delayed compensation, and discusses the benefits of implementing these payment schemes for employees.

What exactly is deferred compensation?

The practice of setting aside a portion of your salary to be paid out at a later date is called deferred compensation, or deferred comp. It is common practice to postpone paying taxes on retained earnings until you actually receive the money. Retirement, stock-option, and pension plans are among the most popular types of deferred compensation.

Deferred compensation types

Two main types of deferred compensation exist, distinguished by their legal status and the motivations behind their use by employers:

Qualified deferred comp plans

Plans like 401(k), 457(b), and 403(b) are eligible deferred compensation plans because they are subject to the Employee Retirement Income Security Act (ERISA). Employers are required by law to provide this type of plan to all workers (except independent contractors) when they implement it. These programs are more safe than others because employee income is shielded from outside influences by being held in a trust account. For instance, the creditors would still have no way of accessing the money, regardless of whether the corporation defaulted on part of its debts.

Contributions to qualified deferred compensation plans are limited by law and regulation, which is another key difference. This means that even high-paid workers may only have a modest portion of their salary that can be put into a qualified plan.

Non-eligible deferred compensation plans

When most people talk about deferred compensation, they usually mean a non-qualified plan. To attract and keep employees, many companies use non-qualified deferred compensation (NQDC) plans, which are also known as 409(a) plans or golden handcuffs. Employees and employers enter into these plans as part of a legally binding agreement; they may also contain supplemental agreements, such as a non-compete clause. A nonqualified deferred compensation (NQDC) can take numerous forms; however, it is most often seen in supplementary executive retirement plans (SERPs), deferred savings plans (DSPs), and stock or options programs.

This type of deferred compensation is still subject to legislation, but it is far more flexible than qualified plans because of the fewer regulations it faces. In particular, there is no mandate that businesses provide them to their employees, there is no limit on how much people can put in, and everyone, including freelancers, can sign up for these programs. This is why many companies only provide these programs to their most prized employees. With NQDC plans, businesses can postpone paying their employees in full while still attracting pricey, skilled staff.

You are free to take your money out whenever you want, but the IRS usually slaps hefty penalties on distributions made too soon. Depending on the specifics of the contract, the firm may be able to keep the money even if the employee has already paid it out. This could happen if the employee starts working for a rival, is fired, or loses the benefit in some other way that breaches the non-compete clause.
It is possible for creditors to confiscate NQDC plans in the event of an organization’s insolvency, unlike qualified plans. This is why, if your distribution is far off or the company’s finances are precarious, non-qualifying deferred compensation schemes could be a bad idea.