Deferred compensation is compensation that is deferred, AKA paid at a later date. Generally, taxes are deferred on this income until it is actually paid out. Examples include stock options, retirement plans and pension plans.
The reason an employee would go for this is the tax benefits they can get. Usually this is when you’re old, gray and retired. Usually you’re in a lower tax bracket when you retire than when you were working, so you’ll end up paying less on that income later on down the road. One exception of note are Roth 401(k)s, which require you to pay taxes on income as you earn it. However, if you plan to be in a higher tax bracket when you retire, it makes since to pay taxes on that income now, and therefore a Roth 401(k) might make the most sense.
Deferred compensation is usually broken up into two categories: qualified and non-qualified. These have really different legal implications and purposes.
Qualified deferred compensation plans are known as pension plans and include 401(k) plans, 403(b) plans and 457 plans. If you have one of those plans in place, you have to offer it to all your employees but you don’t have to extend the offer to people who work as independent contractors. With these types of plans, only a certain amount can be contributed each year and that amount is mandated according to the current law. Qualified deferred compensation cannot be used by the company to pay debts either. It’s just for the person who’s contributing to it to benefit from.
On the other hand, non-qualified deferred compensation (NQDC) plans, 409(a) plans and “golden handcuffs,” (which sounds pretty kinky) give you a way to attract and retain your best employees. In contrast with qualified deferred compensation, you don’t have to offer it to all of your employees and there is no limit on the amount that can be contributed. You are able to include independent contractors for these kinds of plans as well. This means you can hire an employee that demands a high salary without having to take on the full burden of that debt immediately.
By the time I get my deferred compensation, I’m gonna be all old and stuff. But I guess it’s always good to plan for the future.