Deferred compensation is an agreement between an employer and employee where a portion of earnings is withheld for payment at a future time, often used as a retirement savings plan. It has tax advantages and can include stock options as non-monetary compensation.
Deferred compensation is an agreement between an employer and an employee in which a portion of their earnings, or compensation for work performed, is withheld or deferred for payment at a future time. It is widely used as a retirement savings plan. An employer may offer a retirement plan to its employees as part of their compensation package, which may also include health insurance and actual wages. Although the retirement value is not specified in the hourly or annual pay rate, it is in fact deferred compensation that will be provided to the employee at an agreed rate and time.
Some employers participate in a deferred compensation program that allows an individual to have a portion of their hourly or annual wages invested by their employer instead of receiving monetary compensation for work at the time it is performed. There are a number of advantages to this.
One advantage of deferred compensation is that the portion of your compensation that is invested rather than disbursed to the employee is not subject to federal or state income tax at the time it is earned. This is usually the time when a person’s income and consequently his tax liability is greatest. It only becomes subject to federal and state taxes when the employee receives it much later.
In most cases, the employee does not request the payment of deferred compensation until after retirement. At this time, his income and resulting tax liability are generally less. In addition, neither interest nor dividends earned from the deferred payment are subject to federal or state income tax until such time as the employee receives it.
In addition to deferred compensation used for retirement purposes, companies sometimes offer employees stock options. This is when the company’s own shares are issued to the employee as a form of non-monetary compensation. This can be beneficial for both the employee and the company. The employee will benefit if the share price is higher when it is cashed than when it is earned. In turn, the company will benefit as it gives the employee an incentive to do their job with the best interest of the company in mind. The downside of this type of deferred compensation is when the share price is lower when it is sold than when it is earned.
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