Description

• The term "deferred compensation" refers to a financial arrangement, usually between an employer and employee, where a portion of the employee's earned income is paid at a later date. Pensions and retirement plans are examples of deferred compensation. In addition to future financial security, another benefit of deferred compensation plans is the deferral of tax on the income. The income is not taxed until the date it is received. This also allows the deferred funds to collect interest before they are taxed.
  
  

Purpose

• A common purpose of deferred compensation plans, such as 401(k)s and 457s, is to provide workers with future financial stability and income during retirement. Many plans, particularly 401(k) plans and stock options, also encourage employees to spend their career with the same employer.
  
  

401(k) Plan

• A 401(k) plan is a deferred compensation plan that is usually offered to employees by the corporation they work for. In some instances, the employer will match the employee's contribution dollar-for-dollar. 401(k) plans allow employees to set aside their earnings to fund retirement. The income funneled into the plan is tax-deferred and early withdrawal of the funds usually results in an early penalty tax. Additionally, executive indemnity insurance protects deferred compensation plans in the event that a company goes bankrupt.
  
  

457 Plan

• A 457 plan is a deferred compensation plan available to state and federal employees. The plan is similar to a 401(k) plan except that the employer does not match employee contributions. As with the 401(k) plans, all contributed income is tax-deferred until it is distributed.
  
  

409a Plan

• A 409a plan is a deferred compensation plan available to some teachers, if their employer offers it. The plan allows teachers to receive their earnings over a 12-month period instead of being paid only during the months that school is in session. For example, if a teacher makes $54,000 a year, through the 409a plan, the teacher will receive $4,500 for 12 months instead of $5,400 for 10 months, the length of the calendar school year.
  
  

Pension / Retirement Plans

• Pensions, also known as retirement plans, are financial arrangements between employers and employees to provide retired employees with regular income. The employees' earned compensation is deferred tax-free until it is distributed in regular installments during retirement. The employer may or not contribute to the pension or retirement plan.
  
  

Stock Options

• Stock options are issued stock to employees as a form for compensation. Typically, stock options are only made available to management as part of their compensation package, although start-ups will often offer stock options to employees and such outside individuals as suppliers, incorporators and lawyers who helped get the company started. If the stock does well, the individual with stock options will directly benefit by receiving compensation. Since the compensation is provided after the stock options have been awarded, it qualifies as deferred compensation.