What Is a Deferred Compensation Account?

A Deferred Compensation Account can save you thousands in income tax payments.

A Deferred Compensation Account is an agreement where an employer pays out a portion of an employee's income in the future instead of when it is earned. According to the New York Times, usually the top 5 or 10 percent of earners participate in Deferred Compensation Accounts because companies are only allowed to invite highly paid workers.

Examples

Pension and retirement plans, stock options and deferred bonus plans are all examples of Deferred Payment Accounts.

Benefits

Since many employees don't take money out until they retire on a reduced yearly income, the principal benefit for most deferred compensation is deferring and possibly reducing income tax paid. These accounts benefit retirees, salespeople and others whose yearly income may fluctuate and those who could benefit from a form of forced long-term savings.

NQDC

Nonqualified Deferred Compensation (NQDC) accounts don't provide tax benefits because they do not satisfy IRS requirements. These plans fall into four areas: Salary Reduction Arrangements (such as teachers having part of their salary held back during the school year so they can be paid during the summer months), Bonus Deferral Plans, Top Hat Plans (such as Supplemental Executive Retirement Plans for a select group of management or highly paid employees) and Excess Benefit Plans.

Dangers

Unlike secure 401(k) plans, if an employer goes bankrupt, the money in Deferred Compensation Accounts may belong to the company's creditors. It is important to read the fine print before into entering into any agreements.

References

• IRS: Nonqualified Deferred Compensation Audit Techniques Guide 2005
• "The New York Times": The Hidden Peril of Deferred-Compensation Plans