The HR world is flush with compensation management plans to reimburse employees for their work. Today, the hiring landscape is evolving with newer and smarter strategies for wealth maximization. Offering deferred compensation is a surefire way to ensure employees retire with comfortable savings.

This article talks about this compensation model from the employer’s point of view.

You’ll find answers to questions like, what is deferred compensation? Why should you offer it? How do you fund it? What are the tax implications, and how can you use compensation planning tools to design plans?

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Article Roadmap

• What Is Deferred Compensation in HR?
• Types
• Taxation and Accounting
• How To Implement
• HR’s Role in Designing Deferred Plans
• Next Steps

What Is Deferred Compensation in HR?

Deferred compensation is a payment model in which a portion of an employee’s salary pays out later. The amount remains tax-exempt for the duration of the plan.

Employees receive the accumulated sum on a predetermined date in the future or at retirement. Companies offer deferred compensation options in addition to 401K plans to retain and motivate employees.

Deferred payment schemes take on many forms:

• Mutual funds
• Contingency plans
• Insurance schemes
• Stock options
• Retirement support
• Pension plans

Types

The two types of deferred compensation differ significantly in their legalities and purposes from the employer’s point of view.

Qualified

The Employee Retirement Income Security Act (ERISA) is a set of federal laws that protect retirement assets. 401(k) and 403(b) are some common plans under it. The ERISA regulates qualified deferred compensation plans.

Companies offering a 401(k) must offer it to all employees. The government caps the contribution amount to qualified plans. Federal laws also regulate how a company must fund these plans.

The ERISA protects employees who opt for qualified plans in cases of organizational dispute, bankruptcy or insolvency. Even in such contingencies, the retired individual receives the accumulated funds.

Non-Qualified

Employees who like to take a riskier step into the savings game can opt for non-qualified deferred compensation plans (NQDC).

It’s a high-risk, high-reward situation: the ERISA doesn’t protect these plans, but there are no annual contribution limits, and independent contractors are also eligible.

HR offers NQDCs to high-demand employees they want to retain. In some cases, people accept NQDC plans in place of their full compensation right away.

Though NQDCs allow employees to save on taxes for a greater portion of their salaries, creditors can seize these funds if the company ever goes bankrupt.

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Taxation and Accounting

Filing deferred compensation taxes is a baffling task. You’re essentially filing thousands of dollars away to fit tax brackets and regulations of the future. HR professionals typically delegate this to specialized handlers or tax management solutions.

Deferred compensation is often subject to Social Insurance taxes at the time of deferral.

If employees are required to undertake future benefits to collect their deferred pay in an NQDC plan, FICA tax isn’t due until the stipulated service ends.

Employers are subject to numerous deferral laws and restrictions depending on how the plan is set up. Sloppy handling of deferred taxes may invite IRS penalties.

When an employee contributes a percentage of their pay to a non-qualified plan, you owe them money in the future. Accounts payable is the word for the amount you owe them but haven’t paid. Accounts payable are a sort of debt or liability. Credits increase the liabilities of a firm.

To preserve accurate accounting records, you must credit your accounts payable with the amount of deferred compensation. This method establishes proof that you still owe the employee money.

How To Implement

A sturdy compensation policy is a telltale sign of a thriving company culture. Deferred compensation is a niche retention strategy that, if done well, empowers employees to take charge of their financial future.

It fosters an enduring relationship between the employer and the employee, resulting in increased engagement, motivation, loyalty and a positive work environment.

Here are a few ways to implement a plan seamlessly.

1. Maintain Transparency

HR leaders can provide individually crafted documents for each employee and their needs instead of providing a blanket summary of deferred pay.

It’s easier to provide the right information to each employee by segmenting staff according to age, pay and experience.

2. Offer Learning Opportunities

Encourage employee participation in compensation planning by using a variety of training strategies.

For instance, engaging a specialist is best when making crucial tax or income planning decisions.

Interactive media may produce better results when explaining deferred pay to employees in general.

3. Deploy Software

Compensation software is a boon for HR managers that deal with planning and taxation for deferred compensation plans. Here’s why:

Deploying software can help you stick to the organizational compensation plan while designing deferred pay.

Compensation management tools ensure compliance with tax regulations on all legislative levels. They structure deferred plans that check out during IRS audits and establish compliance with FLSA and other laws.

All in all, compensation management software helps secure the financial well-being of both employers and employees.

HR’s Role in Designing Deferred Plans

A study by the Principal finds the answers to the “why” and “how” of HRs offering deferred salaries.

• 66% of employers use deferred compensation plans to retain excelling employees, while 59% use them to recruit top talent.
• Post recruitment, 88% of employers offer deferred compensation to help employees save for retirement beyond qualified plans.
• In 2022, only 24% of deferred compensation plans were employer funded. 76% were financed by employees and employers together.

Financing Deferred Compensation Plans

What’s the best way to fund deferred compensation from an organizational perspective? Here are your options.

Companies can use cash flow to pay for agreed-upon benefits of a non-qualified deferred compensation plan. However, purchasing company-owned cash value life (COLI) or short-term disability insurance (COSDI) for each member is a more stable financing strategy.

For each insurance policy, the corporation remains the owner, premium payer and beneficiary. Insurance premiums are paid by pay deferrals and/or employer contributions.

Policy cash values grow tax-free and can be retrieved through loans or withdrawals to pay plan benefits when the employee retires.

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Next Steps

Besides being a retention tactic, deferred compensation tells your employees that you care about their retired life and investment plans.

Well-thought-out HR practices reflect positive company culture.

In addition to 401 (k) plans, deferred payment is a great way to help employees maximize their wealth. Maintaining transparency about the risks involved in subscribing to non-qualified plans is of prime importance.

Compensation software can help you design tax-compliant deferred payment plans that help your employees save up in the long haul. Our free comparison report includes in-depth product reviews to help you choose the right solution.

Are you using compensation software to design deferred compensation plans? Why/why not? Let us know in the comments.