The Advantages of Deferred Compensation

by David Ingram, Demand Media Google
Deferred compensation can provide a comfortable retirement.

Deferred compensation can provide a comfortable retirement.

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When companies withhold a portion of an employee&amp;#039;s pay until a specified date, usually after the employee retires, that withheld portion is termed deferred compensation. Businesses provide deferred compensation plans to rank-and-file employees as 401(k) and other employee-contribution retirement plans, and to top-level managers in the form of annuities, life insurance policies and stock options. Along with obvious drawbacks to having a portion of your compensation withheld, deferred compensation offers advantages for the future.

The most obvious advantage of deferred compensation is the near-guarantee of reliable retirement income. Employees can use deferred compensation in addition to regular pay to build a considerable nest egg to draw upon in later years. The most basic form of retirement income tied to deferred compensation is an investment product such as a 401(k) or an annuity, which pays out a specific amount for a specified number of years. Retirees can cash in life insurance policies tied to deferred compensation, providing them with a lump sum they can invest, save, spend or do a mixture of the three. Stock options can be utilized all at once for a lump sum return, or traded slowly over time for a more steady income stream.

You can hold deferred compensation payouts in savings if you are covered by a pension plan or independent retirement plan, allowing you to help family members with college expenses, mortgage payoffs and other financial burdens, or even to provide your children with a larger inheritance.

Physicians News Digest states that most contributions that employers make to deferred compensation plans are not taxable. Interest and dividends are not taxable when accrued either; the IRS taxes only amounts that are withdrawn. Individuals usually make withdrawals during retirement, when decreased income pushes them into a lower tax bracket. This allows employees to decrease the taxes imposed on their income during their working years, since money earned then will be taxed at a lower rate in the future. According to, distributions from deferred compensation plans can be rolled into a traditional IRA for further tax protection.

Employers reap tax benefits from offering deferred compensation plans as well, receiving current-year tax deductions for all of their contributions.

Deferred compensation offered in the form of an investment account or stock option has the potential to dramatically increase its expected return over time. Rather than simply receiving the amount that was initially deferred, investment accounts or stock options can increase in value before retirement, magnifying their value. The down side to investments and stock options, of course, is that they can drop in value just as easily as they can grow.

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