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Deferred compensation is a part of an employee’s compensation or wages set aside to be paid out to them later. In many cases, taxes are deferred until funds are paid out. A deferred compensation plan is beneficial when one can reduce present and future taxes by deferring income. The withheld amount of income is paid out to the employee at a specified date, usually at retirement.
Deferred compensation plans are funded informally. Essentially, they are a promise by the employer to the employee to pay the funds deferred at a later specified date plus any investment earnings. However, a 401(k) is more formal and includes an established account by which the employee elects a specific contribution, and sometimes the employer matches a portion thereof.
Employers typically offer deferred compensation plans to retain key employees and executives. Deferred compensation can be qualified or non-qualified. Deferred compensation’s benefit depends upon the individual’s tax situation. A deferred compensation plan is most beneficial when you can reduce present and future tax rates by deferring your income.
A Supplemental Executive Retirement Plan or SERP is an example of a deferred compensation plan aimed at key executives of organizations. A SERP mirrors defined-benefit plans in that they guarantee a set amount at sign-up, which you will receive at retirement. Some common ways of determining and calculating the amount of a SERP include coming up with a flat dollar amount for a specified number of years of service to the company agreed upon at hiring. This can also be determined by using a percentage of an executive’s salary. The plan can be structured for funding by a cash value life insurance policy to pay out to your beneficiaries if you die unexpectedly.
It is important to note that deferred compensation is not always beneficial to every key employee or executive. However, these plans are targeted at such employees because, in many cases, they are an attractive incentive to retain key employees and key executives. A financial professional at Adcock Financial Group can help determine what these plans look like for your organization and how to maximize this incentive for your particular key employees and executives. There are several plans available and many ways to put these plans in place in your organization.