.webp)
.webp)
.webp)
What is deferred compensation?
Deferred compensation
Competitive compensation packages help you build your team and steer your company toward its goals. Options like deferred compensation plans reward employees' current contributions, secure their futures, and make your company an attractive place to work—it's a win-win-win.
Deferred compensation plans are flexible and tax-advantaged, helping you retain top-tier talent. Understanding the available plans and how they differ from other options is vital to nurturing your employees' long-term financial success while growing your company.
In this guide, we'll explore deferred compensation, including qualified versus nonqualified plans, and how these plans compare to other employee retirement accounts in the United States.
What is deferred compensation?
Deferred compensation plans allow employees to postpone receiving part of their compensation package, such as their regular salary or incentive-based compensation, like bonuses. Instead of receiving this pay immediately, employees receive it later, typically at retirement. These plans help employees save for the future and reduce their tax bills.
For example, an employee earning $200,000 annually at age 58 might defer $25,000 annually until retiring at age 65. The employee's deferred compensation plan would then hold $175,000.
How does deferred compensation work?
With a deferred compensation plan, the employer sets aside a portion of the employee's total earnings. The employer and employee decide the amount together. Funds accumulate over time and can't be taxed immediately, so employees only pay federal income taxes on deferred compensation once the money is paid out. Medicare and Social Security taxes may still be required.
When employees receive their deferred compensation, the amount of taxes they pay depends on their current tax bracket. In retirement, this is often a lower tax bracket than during employment. For example, if an employee earns deferred compensation in a state with high income taxes but retires in a state with low or no income taxes, their tax liability could be significantly reduced.
Choosing a deferred compensation plan can help lower employees' total taxable income. In some cases, employees can save on taxes if they withdraw the compensation during retirement at a lower tax rate.
Types of deferred compensation plans
There are two main types of deferred compensation: qualified and nonqualified plans. While both are beneficial for retirement savings, they differ in significant ways.
Qualified deferred compensation plans
Qualified deferred compensation plans include 401(k) plans and specific 403(b) plans. These plans, regulated under federal law, allow employees to contribute a portion of their pretax salary to a retirement account. The money in that account grows tax-deferred until the money is withdrawn in retirement. The taxes are paid when the money is taken out of the account.
The Internal Revenue Service (IRS) sets an annual contribution limit for qualified deferred compensation plans. These funds are highly secure and can't be accessed by creditors in bankruptcy.
Nonqualified deferred compensation plans (NQDC)
NQDC plans are more flexible than qualified deferred compensation plans. These savings plans, contractual agreements between employers and employees, can be part of a company's compensation policy.
NQDC plans are often preferred by executives and high-earning employees because they don't have contribution caps. Funds are accessible when an employee retires but can be paid out for emergencies, disabilities, termination, or a change in company ownership.
The money in NQDC plans is not protected in the same way as the money in qualified deferred compensation plans. Creditors can claim these funds if bankruptcy occurs. Always discuss any changes in compensation plans or company ownership with employees immediately.
Differences between deferred compensation vs. 401k
Deferred compensation and 401(k) plans are two investment options for retirement income. Here's how they compare:
Eligibility and usage
Deferred compensation plans are often used by high-paid employees during peak earning years. These plans help employees defer large amounts of money until around the typical retirement age of 65, and they are typically preferred by high earners because many low-earning employees cannot afford them.
401(k) plans, on the other hand, are available to everyone. In most cases, high-earning employees contribute to both deferred compensation and 401(k) plans.
Contribution limits
401(k) plans have annual contribution limits for employees, like $23,000 in 2024. The benefits of deferred compensation plans include much higher contribution limits, allowing employees to defer as much as 50% of their annual income.
For example, an employee earning $500,000 annually in 2023 could contribute 4.5% of their income, or $22,500, to their 401(k). The same employee could contribute up to $250,000 of their $500,000 income to a deferred compensation plan in 2023.
Tax treatment
When an employee contributes to a 401(k), the funds grow tax-free until withdrawal. With deferred compensation plans, employees pay payroll taxes like Social Security and Medicare but do not pay income taxes until the deferred compensation is received. Deferred compensation plans reduce the employee's taxable income while the funds are being deferred.
Access to funds
401(k) plans offer more flexibility in accessing funds. Early withdrawals are sometimes approved for hardships like unemployment and medical expenses. 401(k) plans can also be borrowed against.
The money in deferred compensation plans is typically locked in until a specified date, and employees cannot access these funds until then. While this helps employees save for the future, that money cannot be accessed for unexpected expenses, and it can also not be borrowed against for loans.
Risk
401(k) plan funds are protected under federal retirement laws. This means the money is secure no matter what. While qualified deferred compensation plan funds are protected from creditors, the money in nonqualified deferred compensation plans is not, making these plans riskier.
Hire and retain global talent with Oyster
Offering competitive benefits is critical to building a global team, and deferred compensation plans are just one tool you can leverage to attract top talent. With Oyster Total Rewards, you can offer tailored benefits to meet the unique needs of your workforce. No matter where your Team Members are located, the comprehensive platform streamlines everything from health benefits to retirement plans, salaries, and equity.
Oyster's strategic approach helps you feel informed and confident so you can choose a compensation model and develop a global compensation plan that allows you to expand faster. Excellent compensation, including employee benefits, helps your team feel valued and supported, enhancing your company's ability to succeed worldwide.
FAQ’s
What happens to deferred compensation if I quit?
It depends on what kind of deferred compensation you have. If it’s a qualified plan like a 401(k), you typically keep your vested balance and can leave it in the plan, roll it over, or take a distribution (with potential taxes and penalties depending on age and circumstances). If it’s a nonqualified deferred compensation (NQDC) arrangement, the “what happens next” is dictated by the plan document and your deferral election—some plans pay out at separation, while others keep the original payout schedule, and many are intentionally inflexible once you’ve elected terms. The detail that catches people off guard is risk: NQDC amounts are generally treated as an unsecured promise to pay, so they don’t have the same protections you’d expect in a qualified retirement plan.
Is a 457(b) plan the same thing as deferred compensation?
A 457(b) is a specific type of deferred compensation plan under the tax code, and it’s commonly offered by government employers and certain tax-exempt organizations. People use “deferred compensation” as a broad umbrella term, but in practice a 457(b) has its own rules around eligibility, contribution limits, and distribution triggers that can differ from a 401(k) or from executive-style NQDC plans. If you’re comparing a 457(b) to other options, start with your employer type, then confirm the plan’s distribution rules for separation from service, retirement, and emergencies—because “deferred” doesn’t always mean “locked until 65.”
How do I know if a deferred compensation plan is qualified or nonqualified?
Ask two questions: is the plan governed by standard retirement-plan rules with broad employee eligibility and IRS-set contribution limits, and are the assets held in a protected trust or custodial account for participants? If the answer is yes, you’re usually looking at a qualified plan. If the plan is a separate agreement offered to a narrower group (often executives or highly compensated employees), allows deferrals above typical retirement-plan limits, and is essentially the company’s promise to pay later, it’s typically nonqualified. When in doubt, read the plan document or summary plan description and look for the legal framework it cites—this isn’t a branding exercise, it’s a risk and tax-timing decision.
Can I change my deferred compensation election later if my finances change?
Usually, not easily—and that’s by design. Qualified plans like 401(k)s tend to let you adjust contributions throughout the year (within plan rules). Nonqualified deferred compensation is often much stricter: elections are typically made in advance, changes may be limited to specific windows, and payout timing changes can trigger complex compliance rules. The practical takeaway is to treat NQDC elections like a long-term commitment, stress-test your cash-flow needs first, and coordinate with a tax advisor before you lock anything in—especially if you’re also balancing equity compensation, bonuses, or relocation plans.
How do I estimate the true cost of offering deferred compensation as part of total rewards?
Don’t just price the headline benefit. Model the full employer cost: payroll taxes that may still apply to deferrals, any employer match or crediting rates, administrative and recordkeeping fees, and the internal time your HR and Finance teams spend managing elections, notices, and offboarding payouts. Then pressure-test the “people cost” side, too, like what happens if someone changes countries, moves into a different tax regime, or exits unexpectedly and triggers accelerated payments. If you’re hiring in multiple locations, you can sanity-check country-by-country employment cost assumptions with Oyster’s Global Employment Cost Calculator before you finalize a rewards design, so Finance isn’t surprised later.
.webp){kind=icon}
About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, hire, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
Related Resources
.avif)
