What Is an Elective Deferral?

An elective deferral is a type of contribution that is made into the retirement plan of an employee by the employer. The unique thing about this type of contribution is that the employee could have received the contribution as cash rather than having that amount deposited into the retirement account. Choosing this voluntary course of action results in deferring the need to pay taxes on that amount in the year that the contribution takes place, although the employee will pay taxes on the funds when they are eventually disbursed from that account.

Sometimes known as a salary deferral, the elective deferral is typically a contribution above and beyond any employer contributions to a retirement plan, such as a 401(k) plan. In this instance, the employee chooses to have a portion of his or her salary or wages withheld by the employer and diverted to the retirement account. If the employee also earns a commission, it is possible to divert some of that income into the retirement plan as well. The contributions are generally considered pre-tax, which means the amount of those contributions are not subject to taxes at the time they are earned. Instead, the tax obligation is deferred until the employee begins to withdraw those funds after retirement.

In nations that allow elective deferral as a means of growing the balance in a retirement account, there is usually some sort of limit or cap on the amount that an employee can contribute on an annual basis. It is not unusual for that amount to vary, based on whether the individual is married, has a legally recognized civil partner, or is single. The average annual salary or wages of the employee will also often determine the maximum amount of the elective deferral for a given calendar year. When both spouses work and contribute to different types of retirement plans offered by their respective employers, there is sometimes a cumulative total that the couple cannot exceed in terms of the annual elective deferral.

One of the benefits of the elective deferral is that this option can reduce the tax obligation in the current tax year. Depending on the amount of the contribution, using this approach may be enough to prevent the taxpayer from falling into a higher tax bracket, which means that the savings on taxes may be considerable. A qualified tax professional can assess the financial circumstances of the employee and identify how much of a tax benefit is received from contributing the maximum elective deferral for the year.