Deferred compensation is an addition to an employee's regular compensation that is set aside to be paid at a later date. In most cases, taxes on this income are deferred until it is paid out.

There are many forms of deferred compensation, including retirement plans, pension plans, and stock-option plans.How Deferred Compensation Works

An employee may negotiate for deferred compensation because it offers immediate tax benefits. In most cases, the taxes due on the income is deferred until the compensation is paid out, often when the employee reaches retirement age.

If employees expect to be in a lower tax bracket after retiring, they have a chance to reduce their tax burden.

Roth 401(k)s are an exception, requiring the employee to pay taxes on income as it is earned. The balance in a Roth account is, however, normally tax-free when it is withdrawn. For this reason, it can be a better option, particularly for people who expect to be in a higher tax bracket after they retire.

There are two broad categories of deferred compensation: qualified deferred compensation and non-qualified deferred compensation. These differ greatly in their legal treatment and, from an employer's perspective, the purpose they serve.

Qualified deferred compensation plans are pension plans governed by the Employee Retirement Income Security Act (ERISA), a key set of federal regulations for retirement plans.

They include 401(k) plans and 403(b) plans.

A company that has such a plan in place must offer it to all employees, though not to independent contractors.

Funds in qualifying deferred compensation plans are for the sole benefit of their recipients. Creditors cannot access the funds if the company goes bankrupt. Contributions to the plans are capped by law.

Non-qualified deferred compensation (NQDC) plans are also known as 409(a) plans and "golden handcuffs," As the name implies, they are typically offered only to top-level executives and key talent that the company really wants to retain.

They do not have to be offered to all employees. They also have no caps on contributions.

Independent contractors are eligible for NQDC plans. For some companies, they are a way to hire expensive talent without having to pay their full compensation immediately, meaning they can postpone funding the obligations. That approach, however, can be a gamble for the employee.

NQDCs are contractual agreements between employers and employees, so they are more flexible than qualified plans. For example, an NQDC might include a non-compete clause.

Compensation is usually paid out when the employee retires, although there can be provisions for earlier payouts in case of certain events like a change in ownership of the company or a strictly defined emergency. Depending on the terms of the contract, deferred compensation might be canceled by the company if the employee is fired, defects to a competitor, or otherwise forfeits the benefit. 

Early distributions on NQDC plans trigger heavy IRS penalties.

From the employee's perspective, NQDC plans offer a reduced tax burden and a retirement savings bonus. This is especially valued by highly compensated executives because their qualified 401(k) plans have annual contribution limits.

On the downside, the money in NQDC plans does not have the same protection as a 401(k) balance. If the company goes bankrupt, creditors can seize funds for NQDC plans.

NQDCs take different forms, including stock or options, deferred savings plans, and supplemental executive retirement plans (SERPs), otherwise known as "top hat plans."

Deferred compensation is an addition to an employee's regular compensation that is set aside to be paid at a later date. In most cases, taxes on this income are deferred until it is paid out.

There are many forms of deferred compensation, including retirement plans, pension plans, and stock-option plans.How Deferred Compensation Works

An employee may negotiate for deferred compensation because it offers immediate tax benefits. In most cases, the taxes due on the income is deferred until the compensation is paid out, often when the employee reaches retirement age.

If employees expect to be in a lower tax bracket after retiring, they have a chance to reduce their tax burden.

Roth 401(k)s are an exception, requiring the employee to pay taxes on income as it is earned. The balance in a Roth account is, however, normally tax-free when it is withdrawn. For this reason, it can be a better option, particularly for people who expect to be in a higher tax bracket after they retire.

There are two broad categories of deferred compensation: qualified deferred compensation and non-qualified deferred compensation. These differ greatly in their legal treatment and, from an employer's perspective, the purpose they serve.

Qualified deferred compensation plans are pension plans governed by the Employee Retirement Income Security Act (ERISA), a key set of federal regulations for retirement plans.

They include 401(k) plans and 403(b) plans.

A company that has such a plan in place must offer it to all employees, though not to independent contractors.

Funds in qualifying deferred compensation plans are for the sole benefit of their recipients. Creditors cannot access the funds if the company goes bankrupt. Contributions to the plans are capped by law.

Non-qualified deferred compensation (NQDC) plans are also known as 409(a) plans and "golden handcuffs," As the name implies, they are typically offered only to top-level executives and key talent that the company really wants to retain.

They do not have to be offered to all employees. They also have no caps on contributions.

Independent contractors are eligible for NQDC plans. For some companies, they are a way to hire expensive talent without having to pay their full compensation immediately, meaning they can postpone funding the obligations. That approach, however, can be a gamble for the employee.

NQDCs are contractual agreements between employers and employees, so they are more flexible than qualified plans. For example, an NQDC might include a non-compete clause.

Compensation is usually paid out when the employee retires, although there can be provisions for earlier payouts in case of certain events like a change in ownership of the company or a strictly defined emergency. Depending on the terms of the contract, deferred compensation might be canceled by the company if the employee is fired, defects to a competitor, or otherwise forfeits the benefit. 

Early distributions on NQDC plans trigger heavy IRS penalties.

From the employee's perspective, NQDC plans offer a reduced tax burden and a retirement savings bonus. This is especially valued by highly compensated executives because their qualified 401(k) plans have annual contribution limits.

On the downside, the money in NQDC plans does not have the same protection as a 401(k) balance. If the company goes bankrupt, creditors can seize funds for NQDC plans.

NQDCs take different forms, including stock or options, deferred savings plans, and supplemental executive retirement plans (SERPs), otherwise known as "top hat plans."