Q:

What is deferred compensation?

A:

Quick Answer

Deferred compensation, or the deferring of taxes on income until it’s withdrawn, can refer to pensions, stock options and retirement plans. Qualifying plans that allow for deferral of taxes must comply with the Employee Retirement Income Security Act of 1974. Other types of deferred compensation are typically taxed when earned.

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Full Answer

Employees and employers agree in writing to have compensation deferred and given to them at a selected date in the future. If the compensation is due much later in the future, an investment method may also be provided that may allow for the money to grow over time.

Qualifying plans include 401(k), 403(b), and 457(b). Plans may include a matching component, wherein employers match a certain percentage of deposits into the account, as well as possible profit sharing lump sum payments. Employees pay taxes on the amounts when they eventually withdraw the money from the accounts. Exact requirements to withdraw money vary, and the amount of tax may change by the time the employee can withdraw the money.

Non-qualifying plans, ones that are taxed when received, typically have more flexibility for the employer. With non-qualifying plans, employers can give compensation to a limited group of employees, treat each employee differently and provide the compensation to independent contractors.

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