Deferred Compensation
A portion of an employee's earnings set aside to be paid at a future date, typically at retirement, providing a tax deferral benefit.
What is Deferred Compensation?
Deferred compensation is an arrangement in which a portion of an employee's earned income is withheld by the employer and paid at a later date — most commonly at retirement, disability, or termination. Qualified deferred compensation plans (such as 401(k) and 403(b) plans) meet IRS requirements and allow pre-tax contributions, reducing current taxable income; earnings accumulate tax-deferred until withdrawal. Non-qualified deferred compensation (NQDC) plans are typically used for highly compensated executives and offer greater flexibility but fewer protections — funds are at risk if the employer becomes insolvent. Under GAAP (ASC 710), deferred compensation obligations are recorded as liabilities on the employer's balance sheet as compensation is earned.
Example
A Fortune 500 company offers its senior executives a non-qualified deferred compensation plan allowing them to defer up to 50% of their annual bonus. The CEO defers $500,000 of a $1 million bonus, reducing her current-year taxable income by $500,000. The company records a $500,000 deferred compensation liability on its balance sheet. The deferred funds are invested in a rabbi trust — protected from general creditors in normal operations but accessible to creditors in bankruptcy — and paid out with accumulated gains when the CEO retires.