Deferred compensation is a benefit provided by an organization in order to reward and help retain key executives, as well as make the company more attractive to the very best candidates for filling key positions. In their simplest form, deferred compensation plans are arrangements between the organization and a key employee where a portion of the employee's income is paid out at a later date than it was earned. Usually deferred compensation refers to "non-qualified" deferred compensation, but loosely the term can apply to any arrangement where an employee receives wages after they are earned. The primary advantage of most deferred compensation plans is the deferral of tax on the income until the date(s) it is actually received.
Deferred compensation plans are flexible and may be designed in a way that is mutually agreeable to both the company and the key employee. A company may choose which key employees will receive this benefit. Typically a company will make contributions of additonal amounts, cash or otherwise, to the employee's deferred compensation plan account, which are often tied to the earnings of the employer in order to create an incentive for high performance on the job. If the key executive terminates his or her services prior to the dates stated in the agreement, only the amounts deferred by the executive are payable to him or her; the employer's additions are forfeited. This can help increase retention rates of an organization's most valuable executives.
Your company will need to make numerous decisions when designing any deferred compensation plan. One of the most important is whether the plan is to be "funded" (by specific company assets allocated to payment of the benefit) or "unfunded." Although they can use the general assets of the company to support deferred compensation benefits, "unfunded" plans are usually infomally funded instead through life insurance policies purchased to enable the employer to provide the promised benefits, as deferred compensation obligations can become quite substantial. Your agent can help you navigate the complexities of informally funding your deferred compensation benefits through life insurance as well as the potential advantages for both the employer and the employee of doing so.
*Note: It is impossible to discuss all the risks, benefits and potential tax consequences of deferred compensation plans on this site. Please seek the advice of your agent, your accountant and/or tax expert when designing a deferred compensation plan.
*With all life insurance policies any/all guarantees are backed only by the claims paying ability of the individual carrier.