What is a Deferred Compensation Plan?
A deferred compensation plan is an arrangement whereby an executive or owner defers some portion of their current income until a specified future date. Wages earned in one period are actually paid at a later date. The employer can also make contributions into the plan and apply a vesting schedule to increase the retention aspect of the plan.
Earning on the deferred amounts can be tied to the performance of specific mutual funds, credited at a fix rate of return or tied to an index.
The amounts deferred and earnings will not be taxable to the executive until time of payout. At time of payout the company will receive the compensation deduction for payments made.
The advantages of a nonqualified plan are:
- the employer can pick and choose among the recipient employees without regard to years of service, salary level or any other criteria
- allows a business to provide benefits to officers, executives and other highly paid employees with fully customizable vesting schedules
- the amount of the employer’s contributions are not limited
- there are no significant filing or reporting requirements
Note: There are special timing rules related to FICA taxes and income taxes.
The disadvantages of a qualified plan include:
- the employer is not entitled to tax deductions until such time as the benefits are actually paid to the employee
- distributions are not eligible for rollover to an IRA or other qualified plan, thereby permitting further tax deferral.
- Account balance are subject to the claims of corporate creditors until time of distribution