Deferred compensation is a financial strategy individuals use to manage their income more efficiently. It allows employees to postpone receiving a portion of their earnings until a future date, like retirement.
For employers, offering deferred compensation plans can be a valuable way to attract and retain talent. This article highlights the types of deferred compensation, potential risks, employer benefits, and how Mosey can help maintain business compliance.
What Is Deferred Compensation?
Deferred compensation is an agreement between an employer and an employee to postpone a portion of the employee’s earnings until a future date. For companies that offer it, this is typically included as part of a compensation package.
Deferred compensation can come in various forms, including retirement plans, stock options, or bonus deferrals, to name a few. Employees can benefit from tax deferrals and the investment growth accrued from these plans.
There are several different types of deferred compensation to choose from. However, it may be overwhelming for employees to sort through the options when they are unfamiliar with the concept, so it is important for employers to help them understand the basics.
What Are the Types of Deferred Compensation?
There are many types of deferred compensation plans available, each designed to meet a different set of needs and goals. By exploring the different types of deferred compensation plans, employees can make informed decisions regarding their financial future.
Qualified Deferred Compensation Plans
Qualified deferred compensation plans are those that meet the requirements set by the Internal Revenue Service (IRS), 401(k) plans, for example. These plans offer advantages like tax deferrals on contributions and investment earnings.
Some companies include employer matching, motivating employees to contribute more to their retirement funds. Businesses offering this are subject to strict regulatory guidelines, including non-discrimination laws that prevent them from favoring employees with higher salaries.
Non-Qualified Deferred Compensation Plans (NQDC)
Nonqualified deferred compensation (NQDC) plans are not subject to the same IRS regulations as qualified plans, allowing for greater flexibility. These plans are often used to provide additional compensation to certain executives and high-earning employees beyond what is available through qualified plans.
NQDC plans can be tailored to meet the specific needs of both the employer and the employee, offering features like varied deferral periods, different payout options, and unique investment choices. However, they do not offer the same tax advantages as qualified plans.
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Supplemental Executive Retirement Plans (SERPs)
Supplemental executive retirement plans (SERPs) are a type of non-qualified deferred compensation plan. SERPs provide additional retirement income beyond what is available through standard qualified plans. These plans are highly customizable, allowing employers to tailor benefits to meet the unique needs of their top performers.
SERPs can include various perks, like guaranteed payouts, investment options, and performance-based incentives, making them an attractive option for both employers and executives seeking valuable retirement benefits.
Stock Options and Equity-Based Plans
Stock options and equity-based plans allow employees to purchase company stock at a predetermined price, typically offering certain financial incentives tied to the company’s performance.
Common equity-based plans include:
- Employee stock purchase plans (ESPPs): ESPPs allow employees to buy company shares, typically at a discount.
- Restricted stock units (RSUs): RSUs provide employees with company shares they can earn over time, encouraging them to remain with the company and perform well.
- Stock appreciation rights (SARs): SARs offer employees the ability to earn from the increase in company stock value over a certain period of time, rewarding them for contributing to the company’s success.
These equity-based plans help drive motivation and keep employees in their positions longer by rewarding them for their commitment to the business.
Deferred Profit Sharing Plans (DPSPs)
Deferred profit sharing plans (DPSPs) allow employers to share a portion of their profits with employees. DPSPs link compensation to the company’s financial performance, so the better the business performs, the more employees can earn.
Employees benefit from additional income sources like this one as they can boost their retirement savings. DPSPs can also serve as a tool for attracting and retaining talent — demonstrating a company’s commitment to sharing success with its workforce.
457 Plans
Primarily, 457 plans are available to state and local government employees, as well as some non-profit organizations. These plans function similarly to 401(k) plans, allowing for the deferral of compensation with tax advantages.
These plans offer flexibility in both contributions and withdrawals, making them an attractive option for public-sector employees who may have different retirement planning needs than those in the private sector.
Participants can contribute a portion of their salary on a pre-tax basis, and the investments grow tax-deferred until withdrawal. Additionally, 457 plans often allow for “double contributions” if an employee works for multiple employers.
Executive Bonus Plans
Executive bonus plans are designed to provide additional benefits to executives, like life insurance, and are funded by the employer. These benefits are typically paid out at retirement or upon termination of employment.
These plans can provide financial security and act as an incentive for executives to remain with the company long-term. Additionally, executive bonus plans are flexible and can be tailored to meet the employer’s and executive’s specific needs and preferences.
Deferred Compensation Trusts
Deferred compensation trusts provide additional security for deferred funds, ensuring the compensation is available when it is needed. By placing deferred compensation in a trust, employers can protect the funds from being used for other business purposes.
These trusts offer peace of mind to employees, allowing them to see their deferred earnings are being managed responsibly and will be accessible in the future. Deferred compensation trusts also make it easier to manage large amounts of money, given that it is all kept in one place.
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Phantom Stock Plans
Phantom stock plans offer benefits that mirror the value of company shares without actual stock ownership, allowing employees to receive cash payments based on the company’s market performance.
These plans are great for companies that want to incentivize employees without issuing additional shares. Phantom stock plans can include various features, like vesting schedules and performance targets, that help motivate employees to contribute to the company’s success.
Cash Balance Plans
Cash balance plans are hybrid retirement plans that combine the features of traditional defined benefit and defined contribution plans. They offer employees predictable retirement benefits while allowing for individual investment choices.
Employers can tailor these plans to meet their financial objectives and provide competitive retirement benefits while employees enjoy a clear understanding of their retirement savings and growth potential.
Immediate Deferred Compensation Plans
Unlike traditional deferred plans that defer compensation until retirement, these plans offer the option to defer income at any point during the employment period. This flexibility can be beneficial for employees who anticipate changes in their financial situation or tax status.
Immediate deferred compensation plans can also be customized to align with financial goals, offering options like lump-sum deferrals or periodic contributions. Employers can use these plans to provide additional financial incentives.
Longevity Plans
Longevity plans are designed to provide additional compensation based on the number of years an employee has spent with the company. They can include features like tiered deferral percentages and benefits for milestone years.
By tying deferred compensation to how long employees stay, employers can create a more stable workforce, lower turnover, and keep valuable knowledge within the company.
What Are the Risks of Deferred Compensation?
While deferred compensation offers tax benefits, it also comes with potential risks and strict regulatory requirements. Non-qualified deferred compensation plans are subject to IRS rules. Failure to comply with these rules can result in tax penalties for both employers and employees.
Additionally, deferred compensation is considered unsecured debt, meaning it would be subject to the company’s creditors in the event of bankruptcy. Employers must stay informed about ever-changing tax laws to maintain compliance and protect the interests of their employees.
How Does Deferred Compensation Benefit Employers?
One of the primary benefits of offering deferred compensation is its ability to attract and retain skilled employees. Deferred compensation plans are often viewed as valuable perks, making positions that offer them more highly sought after on the job market. Employees are more likely to stay with a company that offers long-term financial incentives.
This helps lower the costs associated with hiring and training new staff, enabling businesses to put those funds towards other areas. Deferred compensation also provides employers with financial flexibility by helping them manage cash flow more effectively—instead of paying out large sums immediately, companies can spread payments out over time.
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Mosey’s compliance platform simplifies the process of registering for state and local payroll tax accounts across all 50 states, ensuring businesses can quickly and accurately set up payroll in new locations while remaining compliant.
Additionally, our platform can detect changes to laws and regulations where your employees reside so you can update your policies promptly. By automating tax registrations, we reduce administrative burdens, lowering the risk of penalties and allowing you to focus on growing the business. Schedule a demo with Mosey today to learn more.
