Overall, deferred compensation plans are either qualified or non-qualified. The primary difference between the two types is that the latter is not eligible for tax deferral. In most cases deferred compensation is scheduled to be paid after termination of employment with a company.
Qualified deferred compensation plans are essentially vehicles for retirement savings. They include long-term investments and pensions. Income that is set aside on this kind of plan is not taxed when it is earned, but rather when it is drawn. One of the benefits of paying taxes later is that the employee will be in a lower tax bracket upon reaching retirement age.
Non-qualified deferred compensation plans come in a wider array of configurations. One of the primary benefits of this type of plan is that it gives employees an incentive to remain loyal to an employer. They can be excess benefit or supplemental executive retirement plans. Other plans of this nature may include bonus deferral or salary reduction arrangements.
The structure of deferred compensation plans varies among companies. Some have elective plans, while others are non-elective. The former consists of employees deciding to have a certain amount deducted from their salaries. Non-elective plans do not take from employees’ salaries, but rather function as an extension of their compensation.
An employee who chooses to defer compensation of payments such as those from salary and bonuses will typically do so in order to save for retirement and benefit from lower taxes. In order for this action to be valid, the employee must choose to defer payment before the compensation in question has been earned. As the employee chooses to participate in this kind of plan, there is no need to be vested. All money set aside must be returned to the employee upon termination of employment, for whatever reason and within any period of time.
Employees who are automatically enrolled in deferred compensation plans have fewer options. This kind of deferment is considered a benefit that is awarded to employees who remain with the company for a certain number of years. If the employee is not fully vested upon termination, then the benefit is lost.
Deferred compensation is a situation in which a portion of an employee’s income is paid later then when it has been earned. In some cases, these plans are funded by life insurance. Upon retirement age, they are then made available to the individual in cash.