What is Deferred Compensation

Deferred compensation refers to a portion of an employee's compensation that is set aside to be paid out at a later date, usually for tax advantages or retirement planning. It includes pension plans, 401(k) plans, and other forms of retirement savings. In HR, it is a tool used to align employee incentives with long-term company goals.

Key Features of Deferred Compensation

• Tax Benefits: Employee and employer contributions are usually made pre-tax, reducing taxable income today and providing tax-deferred growth until retirement.

• Employee Retention Tool: Often used to encourage long-term employment, as funds may only be accessed after a certain period or aging, such as reaching retirement age.

• Variety of Plans: Includes different types such as 401(k)s, pension plans, and non-qualified deferred compensation plans tailored to executive management.

Importance of Deferred Compensation in HR

Deferred compensation is significant for HR professionals as it serves as a strategic tool in talent acquisition and retention. It helps attract high-potential employees with the promise of future financial stability. For example, offering a robust 401(k) match may attract employees who prioritize long-term financial security. It also helps companies manage their cash flow by deferring some compensation expenses.

Related Terms: 401(k) Plan, Pension Plan, Non-Qualified Deferred Compensation Plan, Benefits Administration

Comparison: Deferred Compensation vs. Immediate Compensation

While deferred compensation is paid at a future date, immediate compensation is paid out during the current pay period. Immediate compensation is subject to immediate taxation and includes salary, bonuses, and wages, offering immediate financial liquidity to employees.

Benefits of Deferred Compensation

• Tax Efficiency: Reduces taxable income during earning years and allows tax-deferred growth.

• Financial Security: Offers long-term financial planning through retirement savings.

• Employee Loyalty: Increases employee retention by promising future benefits.

Best Practices for Deferred Compensation

• Clear Communication: Ensure employees fully understand their deferred compensation plans, including vesting schedules and tax implications.

• Regular Review: Periodically assess and adjust deferred compensation plans to align with market trends and employee needs.

• Customization: Tailor plans to fit different employee needs and organizational objectives.

Frequently Asked Questions (FAQs) about Deferred Compensation

Q: What are the risks of deferred compensation?

A: Deferred compensation is subject to the employer's solvency since payments occur in the future. If the company faces financial trouble, the deferred compensation could be at risk.

Q: How does deferred compensation affect retirement planning?

A: It provides an avenue to save pre-tax dollars for retirement, often supplementing other retirement savings plans and contributing towards financial stability during retirement.

Q: Are there contribution limits to deferred compensation plans?

A: Contribution limits depend on the type of plan. For qualified plans like 401(k)s, there are federal limits, while non-qualified plans may offer more flexibility.