Are you thinking about your future financial security? If you’re an employee, you may have heard about deferred compensation plans as a way to save for retirement. But what exactly is deferred compensation, and how does it work? Let’s dive into the world of deferred compensation to understand its ins and outs.
What is deferred compensation?
- Deferred compensation is an agreement allowing employees to receive a portion of their wages at a later date, usually upon retirement.
- Some examples of deferred compensation plans include bonus deferral plans, excess benefit plans, salary reduction arrangements, and Supplemental Executive Retirement Plans (SERPs).
How deferred compensation works
- Your employer may offer deferred compensation plans as part of your benefits package.
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By deferring a portion of your wages until retirement, you are ensuring a comfortable financial future for yourself.
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Key decisions when signing up for deferred compensation involve determining how much to defer, the duration of deferral, and the payout options (lump sum or multiple payments).
Types of deferred compensation plans
- Nonqualified deferred compensation (NQDC) plans, also known as Section 409A plans, include bonus deferral plans, excess benefit plans, salary reduction arrangements, and SERPs.
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Qualified deferred compensation plans, governed by the Employee Retirement Income Security Act of 1974 (ERISA), include 401(k), 403(b), Keogh plans, and SEP IRAs.
Nonqualified deferred compensation plans vs. 401(k)
- Nonqualified plans have no contribution limits, while qualified plans have set yearly contribution limits.
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Employers can offer nonqualified deferred compensation to independent contractors, providing more flexibility in compensation.
Pros and cons of deferred compensation
- Pro: Convenient saving method that automatically withholds money from paychecks.
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Con: Risk for losses in case of employer bankruptcy.
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Pro: Flexibility in choosing when to receive funds and how much to contribute.
Tax implications of deferred compensation
- Taxes on deferred compensation are paid when the funds are received, typically at retirement.
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Consider an installment plan for lower tax rates on deferred income.
Conclusion
Deferred compensation plans can be a valuable tool in preparing for retirement and securing your financial future. Speak to your employer or a financial advisor to learn more and determine if it’s the right option for you. Remember, planning ahead today can lead to a more financially secure tomorrow.
