Deferred Compensation

Understanding the HR Glossary

Deferred compensation is a type of employee benefit in which an employer withholds a portion of an employee's income or bonus and sets it aside to be paid out at a later date, usually upon retirement. This type of compensation arrangement is typically offered to highly compensated employees as a way to defer income tax and maximize retirement savings.

How Does Deferred Compensation Work?

Deferred compensation works by allowing employees to defer a portion of their income until a later date. The deferred amount is usually invested in a tax-advantaged account, such as a 401(k) plan, and grows tax-free until the employee retires and begins to receive the payouts. The employee can also choose when they receive the deferred compensation, such as in a lump sum or through a series of payments over time.

Benefits of Deferred Compensation for Employers and Employees

Deferred compensation plans can provide several benefits for both employers and employees. For employers, it can be a way to attract and retain highly compensated employees by offering an additional retirement savings option. It can also help employers to defer compensation costs and reduce their current tax liability. For employees, deferred compensation plans offer a tax-efficient way to save for retirement, as the deferred amount grows tax-free until retirement. It can also be a useful tool for executives and highly compensated employees to defer a portion of their income and reduce their current tax liability.

Conclusion

Deferred compensation is a popular employee benefit that allows employees to defer a portion of their income or bonus until a later date, usually upon retirement. This type of compensation arrangement can provide several benefits for both employers and employees, including tax efficiency, retirement savings, and reduced tax liability. 

If you're an employer, consider offering a deferred compensation plan as part of your benefits package to attract and retain top talent. And if you're an employee, be sure to take advantage of this valuable benefit to maximize your retirement savings and reduce your current tax liability.