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Deferred compensation is an arrangement where an employee earns income but agrees to receive it at a later date, usually after retirement. This type of compensation is not taxed until it is received, which may result in a lower tax burden if the employee is in a lower tax bracket at the time of receipt.
Key Features of Deferred Compensation:
- Tax Deferral: Taxes are postponed until the compensation is received.
- Types: Includes pensions, retirement plans, and stock options.
- Benefit: Employees may lower their current tax burden by deferring income.
How Deferred Compensation Works:
Employees agree to defer part of their salary, which is then paid out at a later time, such as retirement. This can reduce the amount of income subject to tax in the current year.
Frequently Asked Questions: Deffered Compensation
Is deferred compensation taxed when received?
Yes, it is taxed as ordinary income when the compensation is received, not when it is deferred.
How does deferred compensation benefit me?
It allows you to delay taxes until retirement, when you might be in a lower tax bracket.
Can I access deferred compensation early?
Typically, you cannot access it until the designated time, such as retirement or a specified distribution date.
Are there limits on how much I can defer?
Yes, some plans have limits based on your income or the terms of the agreement.
What happens if my employer goes bankrupt?
If the company is insolvent, you may not receive the deferred compensation unless it’s protected under certain agreements or laws.
Do I pay Social Security and Medicare taxes on deferred compensation?
Yes, FICA taxes (Social Security and Medicare) apply when the compensation is earned, even if it is not received immediately.
