What is Deferred Compensation?

A deferred compensation plan withholds a portion of an employee’s pay until a specified date, usually retirement. The lump sum owed to an employee in this type of plan is paid out on that date. Examples of deferred compensation plans include pensions, 401(k) retirement plans, and employee stock options.

Qualified vs. Non-Qualified Deferred Compensation Plans

A qualified deferred compensation plan complies with the Employee Retirement Income Security Act (ERISA) and include 401(k),  and 403(b) plans. They are required to have contribution limits and be nondiscriminatory, open to any employee of the company, and beneficial to all. They are also more secure, being held in a trust account. Because they utilize before tax dollars they are tax qualified and reduce the employees current year income they are tax deductible.

A non-qualified compensation plan is a written agreement between employee and employers in which which part of the employee’s compensation is withheld by the company, invested, and then given to the employee at some point in the future. There are no restrictions on contribution limits and may be discriminatory, open to select employees, and highly compensated employees. The funds can be held directly by the employer and may be exposed in bankruptcy.

Non-Qualified Deferred Comp (NQDC)

  • The Plan allows a service provider (e.g., an employee) to earn wages, bonuses, or other compensation in one year but receive the earnings - and defer the income tax on them- to a later year. Income Splitting is when a higher income family member transfers a portion of income to a lower income family member through some legal means, such as hiring the lower income family member and deducting the cost of the labor as a legitimate business expense.