Deferred compensation

What is deferred compensation?

Deferred compensation refers to the part of an employee's standard salary or benefits which they have decided to set aside and receive at a later date, usually upon their service retirement. Since it is set aside, the amount won’t be taxed until it is paid to the employee. Deferred compensation provides employees with financial security and peace of mind about their retirement plans.

How does differed compensation work?

Typically, when an employee joins an organization, the employer informs them about any deferred compensation schemes available. If such a scheme exists, the employer will provide details to the employee. The conditions and criteria for the plan are determined by the employer in accordance with statutory regulations for the specific industry or location of the company. However, employees may negotiate with the employer and decide on certain aspects of the amount to be set aside based on their preferences.

Types of deferred compensation schemes

Deferred compensation plans can take various forms, including:

• Deferred Stock Options or Equity: Employees often receive deferred compensation in the form of stock options or equity shares. These are dated for a future date so that they are assured of potential value growth over time.

• Bonus Plans with Delayed Payouts: In this type of deferred compensation plan, the bonuses that employees earn are paid at a later time. The amount of bonuses is decided based on employees’ long-term performance or company goals.

• Retirement or Pension Plans: Some companies offer deferred payments in the form of retirement or pension plans such as 401(k). These plans allow employees to save for retirement with employer contributions. These schemes offer the benefit of tax deferral, meaning taxes are not paid on contributions or earnings until the money is withdrawn upon retirement.

• Severance Packages with Delayed Payments: Severance packages are a form of deferred compensation given to departing employees. The payment is made at a later date so employees can use it as financial support during their transition to new employment or significant life changes.