The world of business only ever seems to become more cutthroat and competitive. Today, the existential threats that are constantly threatening to burst in and uproot even the best-laid business plans are more numerous than ever before. In order to keep these threats at bay and lead a thriving business into the future, business leaders need to seize every potential advantage that comes their way.
One of the many tools that businesses have in their fight to save money and stretch their existing finances are deferred compensation strategies. These are a variety of methods that you can use to defer paying income tax on some of your profits. Deferred compensation strategies often form a key component of a broader tax efficiency plan.
What are Deferred Compensation Schemes
Deferred compensation schemes are an option usually reserved for high earners, so that means anyone who is earning $115,000 or more each year. Under a deferred compensation scheme, the employee would elect to set aside, or defer, a portion of their salary for the current financial year, which will instead be paid out at a later date. By deferring the income until the next fiscal year, workers are able to also defer paying the tax on it. Any businesses in need of a deferred compensation plan should seek the advice of experienced tax professionals.
By using so-called nonqualified deferred compensation schemes, it is possible to set aside more money than would be possible under a 401(k) or similar scheme. Businesses can choose between either paying interest on any deferred income or allow the employee in question to choose from a list of potential investment opportunities, using the deferred funds to purchase them.
While a deferred compensation scheme might sound like a no-brainer for those who are earning above a particular threshold, they are not without their risks. For example, in deferring a portion of their salary, workers are essentially accepting the promise of their employer that they will pay them at a later date. When using a 401(k) or similar scheme, the funds that workers put in are protected in the event that the company encounters financial problems.
Should a business become bankrupt, employees with money tied up in non-qualified deferred compensation scheme will face potentially losing that money. In such an event, any employees with deferrals are classed as unsecured creditors of the business, meaning that they will have to line up behind other creditors to get their money back.
Are They Worth it?
Generally, the financial benefits of deferred compensation schemes are most prominent when the employee can afford to defer the money for an extended period of time. The drawback here is that, even if you can afford to be without the money for the duration of your deferral, your money is being exposed to additional risks.
Deferred compensation schemes can potentially be very beneficial, but they are definitely not without risks. And so, ultimately the decision should be made on the same basis of other investment decisions, can you afford to lose the money? You should never risk money that you can’t afford to lose. If you can afford it and you have confidence in the strength of your employer, then a deferred compensation scheme could be perfect for you.