Deferred Compensation Plans

A deferred compensation plan is an amount of earned income payable at a later date. Most of these plans allow employees to avoid paying taxes on the income savings now, so they can be taxed when the funds are withdrawn from the account. The most common type of deferred compensation plan is a retirement plan, because the income is saved now, and used later when the employee is no longer working. Because taxes are not paid on the income when it is initially saved, taxes are typically lower because people in retirement are typically taxed at a lower rate. When you are taxed at a lower rate, you can save money, compared to if you had paid taxes on the income as it was saved. You end up having more income available for retirement this way. Other examples of deferred compensation plans include stock-option plans and pension plans.

Non-qualified plans mean the employer does not receive tax deductions until the benefits are paid to the employee. When the benefits are paid, they are taxable to the employee. Non-qualified plans are typically less expensive and do not have limitations on employer contributions.

Qualified plans have more significant reporting requirements. Employees who are highly paid may be unable to participate, and there are limitations on how much employers can contribute to the plan. Qualified plans can grow tax-deferred until dispersed. It may also be possible to defer taxes further, as these plans are commonly eligible for rollover into other qualified plans.