What is Deferred Compensation?
Deferred compensation is a financial arrangement in which a portion of an employee's earnings is set aside to be paid at a later date, typically after retirement. This strategy is often utilized within pension plans as part of a comprehensive retirement income strategy.
Types of Deferred Compensation
- Qualified Plans: These include traditional pension plans and 401(k) plans, which provide tax benefits and must adhere to specific regulations.
- Non-Qualified Plans: These plans do not have to comply with the same regulations as qualified plans, allowing for greater flexibility in terms of contribution limits and distribution options.
Benefits of Deferred Compensation
Deferred compensation can be advantageous in several ways:
- Tax Deferral: Employees can defer payment of taxes on the income set aside for retirement, often resulting in a lower tax burden during high-income years.
- Retirement Security: Higher contributions can significantly enhance retirement savings, leading to increased income during retirement.
- Employer Incentives: Many employers offer deferred compensation plans as a means to attract and retain top talent.
Considerations
While deferred compensation plans can be beneficial, they also come with risks, such as loss of funds in case of company bankruptcy or changes to tax laws. It is crucial for employees to evaluate their options and plan accordingly.