Starting a new role as an executive can be an exhilarating experience. You’ll get a higher salary and greater opportunities to save for the future. However, it’s also important to consider your financial planning options when taking on a new position, including deferring a portion of your compensation.
Table of Contents
- What Is Deferred Compensation?
- What Are the Types of Deferred Compensation?
- What Are the Benefits of Deferred Compensation?
- What Are Common Disputes Around Deferred Compensation?
- How Is Deferred Compensation Protected Under New York Law?
- How Is Deferred Compensation Taxed?
- Contact Joseph & Norinsberg for Your Employment Law Cases
What Is Deferred Compensation?
Deferred compensation refers to an arrangement in which payment of a portion of an employee’s earnings is postponed to a future date. This agreement is made between the employer and the employee, and payment is commonly deferred until retirement. However, it can also be scheduled for a different time, such as upon leaving the company or in anticipation of a significant expense, such as funding a child’s college education.
What Are the Types of Deferred Compensation?
Qualified Deferred Compensation Plans
Examples of qualified plans include traditional IRAs and 401(k) plans. Employees contribute pretax dollars to their retirement savings accounts each pay period, but the total cannot exceed the prescribed IRS annual limit.
Non-Qualified Deferred Compensation, or NQDC, Plans
This plan option allows executives to defer a much larger portion of their compensation than other plans, but for similar tax benefits. Many non-qualified plans offer the flexibility to schedule distributions during the employee’s career, rather than only at retirement.
What Are the Benefits of Deferred Compensation?
One of the main reasons individuals may decide to defer compensation is that the funds are not taxed immediately. When the time comes to withdraw the money, your tax situation might differ; for instance, you could be in a lower tax bracket or have relocated to a state with no personal income tax. As a result, you might end up paying a lower tax rate at the time of withdrawal than you would have while earning as an executive.
Employers often use deferred compensation to attract and keep employees, especially those who earn high salaries or hold executive positions. From a financial planning viewpoint, deferred compensation helps employers manage their money and cash flow better over time. This method can help businesses hold onto capital for growth or to meet other financial needs.
What Are Common Disputes Around Deferred Compensation?
Here is a brief overview of common disputes around deferred compensation:
- Classification: A major concern is whether an employer’s deferred compensation plan is a discretionary bonus or a vested pension benefit, which would determine whether the strict standards of the federal Employee Retirement Income Security Act, or ERISA, would apply. If ERISA does not apply, highly paid executives have greater flexibility in deciding how much they can defer.
- Non-Compete Clauses: Some employers may include a clause that requires an employee to forfeit their deferred compensation if they leave to work for a competitor.
- Emergencies: Employees may wish to withdraw their funds early in an emergency. However, the rules governing emergency withdrawals are strict, and disputes can arise over what qualifies as severe financial hardship.
- Employer Financial Health: Non-qualified deferred compensation plans, which can potentially reside within the company’s general funds, could cost participants money if their employers face financial hardship or bankruptcy.
How Is Deferred Compensation Protected Under New York Law?
Deferred compensation arrangements, including non-qualified plans, are subject to New York contract law.
- New York Labor Law §193 prohibits employers from making illegal deductions from employees’ wages, such as deductions for business losses, fines, or cash shortages.
- New York Labor Law §198 outlines a process for employees to recover their full wages, benefits, and wage supplements, including any accrued deferred compensation.
How Is Deferred Compensation Taxed?
How deferred compensation is taxed depends on how, when, and where you choose to receive the money.
In both qualified and non-qualified deferred compensation plans, the money will be taxed when it is distributed to the employee.
If you receive your money as a lump sum, you may pay more taxes than if you were to spread the payments out over time. Individuals with higher incomes usually face higher tax rates. Receiving all the money at once could push you into a higher tax bracket.
Federal tax obligations will be the same no matter where you live. However, at the state level, deferred compensation is generally taxed based on where the income was earned. If you decide to receive your payments in installments over 10 years, the taxation will depend on your state of residence when you receive the money.
For example, if you choose to receive payments over 10 years and relocate to a state that does not impose personal income tax, such as Tennessee, you would not be taxed on the payments you receive.
Contact Joseph & Norinsberg for Your Employment Law Cases
At Joseph & Norinsberg, our attorneys have over 100 years of combined experience advocating for employees’ rights and have secured over $200 million in settlements and verdicts. With a deep understanding of employment law, we pay close attention to the details of each case to ensure the best possible case results.
If you have recently accepted an executive position or are considering a deferred compensation plan, our attorneys are here to assist you.
Contact us online or call 212-227-5700 today for a free consultation.
