Deferred Compensation Plans: A Benefit for Executives and Employers

The most valuable resource a company has is its people. For a company to thrive, it must recruit, retain and reward key employees through a comprehensive and competitive retirement benefit package. The limitations on qualified plans prevent highly compensated executives from accumulating adequate retirement savings to maintain their standard of living in retirement. This has caused some companies to turn to non-qualified deferred compensation plans as a solution. While deferred compensation plans are designed as an executive benefit, they also benefit employers.

A nonqualified deferred compensation plan essentially allows select executives to defer their salary – and taxes – in far greater amounts than allowed by most qualified retirement plans. In many cases, the executive expects to be in a lower tax bracket when he or she receives the income and any earnings. For the executive to avoid taxation, the election to defer income must be made before the money has been earned, and the executive must risk forfeiture of the plan assets by allowing them to remain under the company’s control.

Employers have the option of matching some or all of the deferred money with strings attached. For example, not allowing executives to claim the company match until they become fully vested in the plan can create a powerful incentive for them to stay with the company. Some plans can be structured so that the executive also forfeits the deferred pay if she or he leaves before becoming vested.

Unlike a 401(k) or other employer-sponsored retirement plan, deferred compensation plans typically are not subject to reporting requirements in the Executive Retirement Income Security Act (ERISA). There is no requirement to offer the plan to all executives.

The employer can defer employment taxes until the contribution is earned (vested) or the executive cashes out. When the executive cashes out, the company may be entitled to a tax deduction that year.

Assets in a deferred compensation plan are still considered to be the firm’s assets and are reflected on the balance sheet.