A Guide to Deferred Compensation

Deferred compensation programs allow organizations to incentivize executive and high-level employees to improve long-term loyalty and establish mutual goals that benefit both the receiver of the plan and the organization itself. 

In this guide, we’ll discuss the importance and types of deferred compensation before examining how HR teams can implement this long-term incentive to unlock its full benefits for organizations.

Why does deferred compensation matter? 

Similar to most other long-term incentives, deferred compensation offers distinct benefits to organizations looking to improve retention, attract new talent, and align employee goals to their own. Here are the key advantages of deferred compensation plans: 

• Encourages loyalty: Employees will be more inclined to stay with the organization long-term if they have a deferred compensation plan, as they only receive benefits after a certain tenure or upon meeting specific goals. As a result, organizations can improve their overall retention rates. 
• Promotes goal alignment: Organizations can align employees’ goals with their objectives by linking deferred compensation to organizational success, stock performance, or individual performance targets. Through this approach, employees will be motivated to focus on achievements and milestones that directly contribute to the organization’s growth. 
• Cash flow relief: Since employees’ compensation is deferred to a future date, organizations can effectively manage their cash flow and reduce the immediate financial burden of a cash outlay. 
• Attracts talent: Deferred compensation plans can attract executive talent and other desirable employees seeking long-term financial security. These plans offer flexibility, allowing employees to structure their payout timing based on when they might be in lower tax brackets, such as after retirement, to reduce their overall tax burden.

Types of deferred compensation 

There are two main types of deferred compensation: Qualified Deferred Compensation Plans and Non-Qualified Deferred Compensation Plans (NQDC). 

Qualified Deferred Compensation Plans

Qualified Deferred Compensation Plans are tax-advantaged retirement plans designed to comply with Employee Retirement Income Security Act (ERISA) regulations, ensuring protections for participants. These plans offer a structured retirement savings approach, allowing employees to accumulate funds while benefiting from tax deferral.

The most common types of qualified plans include 401(k) plans, 403(b) plans, and traditional pension plans. In these plans, contributions are made on a pre-tax basis, which lowers the organization’s payroll taxes while enabling employees to save more for retirement or invest in their future without immediate tax liability.

A deferred compensation plan is often in addition to a company’s 401(k) plan, with executives or other high-ranking employees participating in both programs, allowing them to maximize their contributions to the 401(k) while enjoying the benefits of the deferred compensation.

A 401(k) plan that includes employer-matching contributions functions as a form of deferred compensation.

Non-Qualified Deferred Compensation Plans (NQDC)

Non-Qualified Deferred Compensation (NQDC) Plans, also designed primarily for executives and high-earning employees, offer flexibility and enhanced benefits beyond the limitations of qualified plans. Unlike qualified plans, NQDC plans do not adhere to the same contribution limits or regulatory protections, allowing organizations to tailor these plans to meet the individual needs of their key talent.

Common examples of NQDC plans include Supplemental Executive Retirement Plans (SERPs) and 401(k) restoration plans. 

SERPs provide executives with extra retirement income on top of their regular retirement benefits, helping to ensure a comfortable retirement for top employees.

401(k) restoration plans let employees save more by deferring extra income beyond the limits of regular retirement plans, increasing their savings potential.

Alternative ways to receive deferred compensation 

In certain deferred compensation programs, employees may receive equity through stock options or restricted stock units (RSUs) that vest over time, providing tax benefits and immediate value to employees. 

There are also non-equity plans such as Phantom Stock and Stock Appreciation Rights (SARs). These arrangements allow employees to receive cash based on the company’s stock performance without granting actual ownership. Organizations can integrate this approach into their deferred compensation program to further motivate employees while avoiding diluting existing shareholders’ equity.

How HR can successfully implement deferred compensation plans 

HR can adhere to the following best practices to increase the effectiveness and success of deferred compensation plans. 

Communicate openly with employees

When establishing and implementing a deferred compensation plan, HR should clearly communicate the plan’s details, benefits, and any associated risks with applicable employees.

Communicating about pay to establish trust with employees is one of the top Compensation Trends for 2024. Transparency in compensation decisions can result in higher engagement levels and increased employee satisfaction. 

Even non-executive employees should be informed about these plans, as understanding the available benefits prompts a positive perception of the organization’s commitment to their financial well-being.

Knowledge of deferred compensation plans can inspire non-executive employees to improve their performance. Understanding that these benefits are available to higher-level positions can motivate employees to grow in their careers and pursue leadership roles within the organization.

Offer flexibility 

Organizations can tailor the deferred compensation plans to address varying employee needs and financial goals. 

For example, organizations can allow employees to choose the percentage of their income they wish to defer. Some employees may opt for a higher percentage to contribute to their retirement, while others may prioritize immediate expenses by choosing a lesser percentage. 

Providing these options helps employees feel in control of their financial future, making deferred compensation appear even more valuable and beneficial. 

Tie to employee performance

Performance management software plays a crucial role in measuring the effectiveness of deferred compensation plans. By providing deep insights into employee performance, HR teams can assess whether these plans are truly motivating employees and driving desired behaviors. When employees clearly see how their contributions directly impact their financial rewards, they tend to be more engaged and committed to their work.

To maximize the benefits of deferred compensation, organizations can tie these plans to specific performance metrics. This approach reinforces the connection between effort and reward, ensuring employees understand the tangible benefits of meeting or exceeding their targets. For instance, HR can set personalized performance goals for executives, linking a portion of their deferred annual bonus to the success of their departments. If these executives surpass their performance targets, they can receive a significant increase in their deferred bonus, creating a long-term incentive that aligns with organizational goals.

Align plans with long-term goals

The success of a deferred compensation program depends on how it contributes to the organization’s long-term objectives. Due to this, HR should tie incentives provided through the deferred compensation plans with organizational objectives such as performance, profitability, and growth. 

Through these plans, employees should be incentivized to prioritize initiatives and actions that help fuel the organization’s success rather than focusing solely on short-term results or personal gains.

Evaluate and adjust when necessary 

HR must periodically review the deferred compensation program’s performance and solicit employee feedback to assess whether it is meeting the organization’s goals. Other factors can also be analyzed to inform future decisions regarding deferred compensation and other long-term incentives, such as participation and employee retention rates.

Simplify deferred compensation management with beqom 

With beqom’s Compensation Management Software, your organization can efficiently manage deferred compensation programs while maximizing their benefits. Our specialized software supports HR teams in establishing plans that align with market trends and the organization’s specific financial goals.