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Deferred Compensation: What It Is, Plan Pros and Cons
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Deferred Compensation: What It Is, Plan Pros and Cons
A nonqualified deferred compensation plan can reduce your taxable income, but there are risks to consider.
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19 years of experience Expertise Retirement planning investment management investment accountsArielle O’Shea leads the investing and taxes team at NerdWallet. She has covered personal finance and investing for nearly 20 years, and was a senior writer and spokesperson at NerdWallet before becoming an editor. Previously, she was a researcher and reporter for leading personal finance journalist and author Jean Chatzky, a role that included developing financial education programs, interviewing subject matter experts and helping to produce television and radio segments. Arielle has appeared on the "Today" show, NBC News and ABC's "World News Tonight," and has been quoted in national publications including The New York Times, MarketWatch and Bloomberg News. She is based in Charlottesville, Virginia.
Arielle O’Shea leads the investing and taxes team at NerdWallet. She has covered personal finance and investing for nearly 20 years, and was a senior writer and spokesperson at NerdWallet before becoming an editor. Previously, she was a researcher and reporter for leading personal finance journalist and author Jean Chatzky, a role that included developing financial education programs, interviewing subject matter experts and helping to produce television and radio segments. Arielle has appeared on the "Today" show, NBC News and ABC's "World News Tonight," and has been quoted in national publications including The New York Times, MarketWatch and Bloomberg News. She is based in Charlottesville, Virginia. Published in Head of Content, Investing & Taxes + more + more What is deferred compensation? What is deferred compensation? Types of deferred compensation plans Types of deferred compensation plans How deferred compensation works How deferred compensation works Benefits of deferred compensation Benefits of deferred compensation Downsides of deferred compensation Downsides of deferred compensationWhat is deferred compensation?
What is deferred compensation?Deferred compensation is a type of employee benefit plan that allows employees to postpone a portion of their income until retirement or another future date, reducing their current taxable income
Deferred compensation is a type of employee benefit plan that allows employees to postpone a portion of their income until retirement or another future date, reducing their current taxable income Cornell Law School Legal Information Institute. Deferred Compensation. Accessed Apr 20, 2026. .NerdWallet Wealth Partners created a free calculator to estimate your financial independence number, see where you stand, and find out how much you might need to close the gap.
FIND OUT NOWNWWP is an SEC-registered investment adviser. Registration does not imply skill or training. The calculator is provided for informational and educational purposes only.
NWWP is an SEC-registered investment adviser. Registration does not imply skill or training. The calculator is provided for informational and educational purposes only.Types of deferred compensation plans
Types of deferred compensation plansDeferred compensation plans may be qualified or nonqualified.
Deferred compensation plans may be qualified or nonqualified.Qualified deferred compensation plans
Qualified deferred compensation plansQualified deferred compensation plans — such as 401(k)s, profit-sharing plans and pensions — are protected by the Employee Retirement Income Security Act of 1974, which sets strict fiduciary standards for employee benefit plans. For instance, all employees must have plan access, there are restrictions on plan contribution amounts, and plan assets must be held in a separate trust account out of reach of creditors
Qualified deferred compensation plans — such as 401(k)s 401(k)s , profit-sharing plans and pensions pensions — are protected by the Employee Retirement Income Security Act of 1974, which sets strict fiduciary fiduciary standards for employee benefit plans. For instance, all employees must have plan access, there are restrictions on plan contribution amounts, and plan assets must be held in a separate trust account out of reach of creditors Cornell Law School Legal Information Institute. 42 CFR § 413.99 - Qualified and Non-Qualified Deferred Compensation Plans.. Accessed Apr 20, 2026. .» Saving for retirement? Read about other retirement plans
» Saving for retirement? » Saving for retirement? Read about other retirement plans retirement plansNon-qualified deferred compensation plans
Non-qualified deferred compensation plansNonqualified deferred compensation plans, also called supplemental executive retirement plans or elective deferral plans, are not required to follow ERISA guidelines. NQDC plans can offer further flexibility and options for the employee; however, this also means they carry additional risk.
Nonqualified deferred compensation plans, also called supplemental executive retirement plans or elective deferral plans, are not required to follow ERISA guidelines. NQDC plans can offer further flexibility and options for the employee; however, this also means they carry additional risk.These plans have been dubbed “golden handcuffs'' because they're often used as a retention tool for key talent or highly compensated employees. The significant reduction in taxable income is extremely attractive, or “golden.” Because deferred compensation plans may require that you stay with your employer to receive the deferred income, you’re “handcuffed” or heavily incentivized to remain with your company for the longer term
These plans have been dubbed “golden handcuffs'' because they're often used as a retention tool for key talent or highly compensated employees. The significant reduction in taxable income is extremely attractive, or “golden.” Because deferred compensation plans may require that you stay with your employer to receive the deferred income, you’re “handcuffed” or heavily incentivized to remain with your company for the longer term Non-Qualified Deferred Compensation as an Employee Retention Tool. New York State Society of Certified Public Accountants. Accessed Apr 20, 2026. .457 Plans
457 PlansOne common type of deferred compensation is the 457 plan, which refers to employer-sponsored NQDC plans typically available to governmental employees (local and state) along with certain nongovernmental organizations, such as nonprofits
One common type of deferred compensation is the 457 plan, which refers to employer-sponsored NQDC plans typically available to governmental employees (local and state) along with certain nongovernmental organizations, such as nonprofits IRS.gov. Government retirement plans toolkit. Accessed Apr 20, 2026. .How deferred compensation works
How deferred compensation worksTo participate in a deferred compensation plan, two things generally have to exist:
To participate in a deferred compensation plan, two things generally have to exist:A defined enrollment period.
A defined enrollment period.A written agreement with your employer designating details such as:
A written agreement with your employer designating details such as:Amount of income deferred: Employees can defer a portion of their salary, bonus or other eligible cash payments. Your plan may allow you to roll your elections over from year to year, or it may require you to make new elections each year.
Amount of income deferred: Amount of income deferred: Employees can defer a portion of their salary, bonus or other eligible cash payments. Your plan may allow you to roll your elections over from year to year, or it may require you to make new elections each year.Deferral period: You need to schedule when you’d like to receive your deferred income. You may be able to select a lump-sum distribution or installments spread across several years. You may want to have income strategically distributed to meet financial goals, such as future tuition payments or retirement.
Deferral period: Deferral period: You need to schedule when you’d like to receive your deferred income. You may be able to select a lump-sum distribution or installments spread across several years. You may want to have income strategically distributed to meet financial goals, such as future tuition payments or retirement retirement .Investments: Deferred compensation plans typically distribute deferred income in addition to any investment growth you would have earned during the time it was deferred.
Investments: Investments: Deferred compensation plans typically distribute deferred income in addition to any investment growth you would have earned during the time it was deferred. 🤓 Nerdy TipDeferred compensation typically is not placed directly into an actual investment; you designate investment choices for bookkeeping purposes. Your employer uses your choices as a benchmark to calculate appropriate investment returns during the deferral period.
Deferred compensation typically is not placed directly into an actual investment; you designate investment choices for bookkeeping purposes. Your employer uses your choices as a benchmark to calculate appropriate investment returns during the deferral period.Benefits of deferred compensation
Benefits of deferred compensationThere are compelling advantages of deferred compensation plans.
There are compelling advantages of deferred compensation plans.Tax advantages
Tax advantagesWhen you defer income, you also defer federal and state taxes on that income until you receive it. This can be appealing if you’re in a high tax bracket and expect to be in a lower tax bracket in the future. You can reduce your present taxable income and schedule your distributions to arrive when you're in a lower tax bracket.
When you defer income, you also defer federal and state taxes on that income until you receive it. This can be appealing if you’re in a high tax bracket and expect to be in a lower tax bracket in the future. You can reduce your present taxable income and schedule your distributions to arrive when you're in a lower tax bracket.The money you’ve socked away in your deferred compensation plan may grow tax-deferred as well. This usually means you pay taxes on your investment growth when the funds are distributed.
The money you’ve socked away in your deferred compensation plan may grow tax-deferred as well. This usually means you pay taxes on your investment growth when the funds are distributed.» Other tax strategies: Learn how to reduce capital gains taxes
» Other tax strategies: » Other tax strategies: Learn how to reduce capital gains taxes reduce capital gains taxesUnlimited contributions
Unlimited contributionsIf the plan is non-qualified, it’s not subject to ERISA standards and there’s no cap on your contribution amount. This can be helpful for employees who are already maxing out the contribution limits on 401(k)s, IRAs or other traditional retirement plans.
If the plan is non-qualified, it’s not subject to ERISA standards and there’s no cap on your contribution amount. This can be helpful for employees who are already maxing out the contribution limits on 401(k)s, IRAs or other traditional retirement plans.Goal targeting
Goal targetingWith deferred compensation plans, employees can choose when to receive distributions. A plan may allow “in-service” withdrawals or distributions so you can access your deferred income prior to retirement to meet other financial goals or obligations. For example, you may want to buy a new home or pay your child’s college expenses at some point. You can schedule income distributions to meet those needs.
With deferred compensation plans, employees can choose when to receive distributions. A plan may allow “in-service” withdrawals or distributions so you can access your deferred income prior to retirement to meet other financial goals or obligations. For example, you may want to buy a new home or pay your child’s college expenses at some point. You can schedule income distributions to meet those needs.» Other ways to save for college: Learn about 529 plans
» Other ways to save for college: » Other ways to save for college: Learn about 529 plans 529 plansFlexibility
FlexibilityCompared with other retirement accounts such as 401(k)s or traditional IRAs, NQDC plans can offer more flexibility; there are no required minimum distributions or age restrictions on withdrawals.
Compared with other retirement accounts such as 401(k)s or traditional IRAs, NQDC plans can offer more flexibility; there are no required minimum distributions required minimum distributions or age restrictions on withdrawals.Downsides of deferred compensation
Downsides of deferred compensationDeferred compensation also has some important disadvantages.
Deferred compensation also has some important disadvantages.Loss potential
Loss potentialAssets in non-qualified deferred compensation plans are not held in a separate trust; they are commingled with company funds (qualified plans, on the other hand, have ERISA protections). Accordingly, people participating in non-qualified deferred compensation plans could lose money if the company encounters financial hardship or if they leave the company. This makes it important to consider the financial health of the employer when deciding whether to participate in your NQDC plan.
Assets in non-qualified deferred compensation plans are not held in a separate trust; they are commingled with company funds (qualified plans, on the other hand, have ERISA protections). Accordingly, people participating in non-qualified deferred compensation plans could lose money if the company encounters financial hardship or if they leave the company. This makes it important to consider the financial health of the employer when deciding whether to participate in your NQDC plan. 🤓 Nerdy TipDeferred compensation plans can be very complex, which is why it's often a good idea to work with a financial advisor who can help you determine whether it’s better for you to max out other options before contributing to a NQDC plan.
Deferred compensation plans can be very complex, which is why it's often a good idea to work with a financial advisor work with a financial advisor who can help you determine whether it’s better for you to max out other options before contributing to a NQDC plan.Withdrawal restrictions
Withdrawal restrictionsAfter selecting your distribution date, it may be difficult to make any changes, so tread carefully when timing your deferral period. Many employees with access to NQDC plans may also have other forms of equity compensation with a timing element, such as restricted stock units or stock options. Taking a holistic approach can help you plan out your income stream and minimize your potential tax burden.
After selecting your distribution date, it may be difficult to make any changes, so tread carefully when timing your deferral period. Many employees with access to NQDC plans may also have other forms of equity compensation with a timing element, such as restricted stock units restricted stock units or stock options stock options . Taking a holistic approach can help you plan out your income stream and minimize your potential tax burden.In addition, there are some limitations to NQDC plans compared with qualified retirement plans such as 401(k)s. Employees cannot take loans from their deferred compensation plan. And upon receiving plan distributions, funds cannot be rolled into an IRA or other tax-deferred retirement vehicle.
In addition, there are some limitations to NQDC plans compared with qualified retirement plans such as 401(k)s. Employees cannot take loans from their deferred compensation plan. And upon receiving plan distributions, funds cannot be rolled into an IRA or other tax-deferred retirement vehicle.NerdWallet Wealth Partners created a free calculator to estimate your financial independence number, see where you stand, and find out how much you might need to close the gap.
FIND OUT NOWNWWP is an SEC-registered investment adviser. Registration does not imply skill or training. The calculator is provided for informational and educational purposes only.
NWWP is an SEC-registered investment adviser. Registration does not imply skill or training. The calculator is provided for informational and educational purposes only.Investment restrictions
Investment restrictionsSome plans may offer as many investment choices as in a 401(k). Other plans may be more restrictive, offering only limited or expensive investment choices, or potentially only company shares. It could add risk to your overall investment portfolio if you’re overly exposed to your company’s stock or unable to sufficiently diversify your portfolio.
Some plans may offer as many investment choices as in a 401(k). Other plans may be more restrictive, offering only limited or expensive investment choices, or potentially only company shares. It could add risk to your overall investment portfolio if you’re overly exposed to your company’s stock or unable to sufficiently diversify your portfolio diversify your portfolio .» MORE: Learn how employee stock purchase plans work
» MORE: » MORE: Learn how employee stock purchase plans work Learn how employee stock purchase plans workTax changes
Tax changesSome employees intend to move to a lower-tax state when they retire and might consider deferring compensation until they’ve done so. However, certain states base deferred compensation taxes on your elected payout period; for payout periods less than 10 years, you may be required to pay taxes to the state in which the compensation was earned
Some employees intend to move to a lower-tax state move to a lower-tax state when they retire and might consider deferring compensation until they’ve done so. However, certain states base deferred compensation taxes on your elected payout period; for payout periods less than 10 years, you may be required to pay taxes to the state in which the compensation was earned Fidelity. NQDC: Be aware of state taxes. Accessed Apr 20, 2026. . State and federal tax rules change from time to time, so consider consulting with a financial advisor if you’re making long-term plans.Helpful resources
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