Though many Americans are familiar with what a 401k or a Roth IRA is, most are unfamiliar with what deferred compensation plans are. Or how they differ from more traditional retirement saving programs.
What Is Deferred Compensation?
A deferred compensation plan typically benefits individuals who work in higher executive positions (i.e., have an annual income of $200K or more). Depending on your living expenses, you may decide to “defer” a portion of your annual salary (i.e., $50K) for a span of several years, until you reach the legal retirement age (i.e., 65 years old).
Deferred compensation plans offer an additional choice for employees in retirement planning and are often used to supplement participation in a 401(k) plan… .[They help] reduce an individual’s taxable income during the deferral… [and]…increase the availability of tax deductions (Investopedia).
According to the IRS‘s website, employees who participate in a IRC 457(b) plan, can expect the following benefits toward their retirement savings plan:
- Tax-deferred contributions
- Tax-deferred earnings on your retirement money
Of course, as with any retirement plan, you are not allowed to exceed the legal limit of salary contributions set forth each calendar year—according to your individual plan—as this may result in double taxation (IRS).
Types of Deferred Compensation Plans
So far, our focus has been on what a “qualified” deferred compensation plan is vs. a non-qualified plan.
There are key difference between the two plans:
- A qualified deferred compensation plan is governed by IRS regulations (e.g., max on annual contributions, etc.)
- A non-qualified deferred compensation plan is a written agreement between certain employees and an employer, meaning they are not restricted by IRS rules.
- Qualified plans are protected within the organization’s Trust
- Non-qualified plans can be lost if the company files for bankruptcy
One of the key differences between the two plans is how the employer of the organization treats tax deductions:
Qualified plans have tax-deferred contributions from the employee, and employers may deduct amounts they contribute to the plan. Non[-]qualified plans use after-tax dollars to fund them, and in most cases employers cannot claim their contributions as a tax deduction (Investopedia).
However, under a non-qualified deferred compensation plan, employers can still expect the following benefits:
- Employers are given greater flexibility under the plan’s development, as they do not need to comply with strict ERISA
- Employers are not required to offer this plan to every person they employ
- Employers can create plans to offer key leadership members more incentive to remain with organization (company loyalty)
- Employers are not required to file annually with the IRS
Smart Planning Retirement Starts with Focus Financial
Our team of experienced financial advisors can help you plan for the future, stay in compliance with all IRS guidelines, and enjoy the type of prosperous retirement you deserve! To get started, you can find an advisor near you to set up consultation.
Remember, it’s never too early to start planning for the future, and it’s never too late to make the right financial decisions that will impact your retirement savings.