Summary of Deferred Compensation
- What is the accounting entry for deferred compensation?
- What kind of account is a deferred compensation account?
- What is the accounting entry for deferred income?
- How is deferred compensation paid out?
Search Results
AI Overview
AI Overview
Accounting for deferred compensation involves recognizing an expense and a corresponding long-term liability (often “Deferred Compensation Payable”) as employees earn the benefit, typically based on the present value of future payments
. It requires accruing the obligation over the service period, commonly using a straight-line method.
Key Accounting Components
Expense Recognition: Debit “Deferred Compensation Expense” to reduce net income in the period it is earned.
Liability Recognition: Credit a “Deferred Compensation Liability” account to reflect the amount owed.
Measurement: The liability is generally recorded at the present value of future payments, using the company’s incremental borrowing rate.
Adjustments: The liability may be adjusted over time based on performance metrics or for interest accretion.
Specific Considerations
Nonqualified Deferred Compensation (NQDC): These plans are often for executives and require accrual over the vesting period.
Qualified Plans: These (e.g., 401(k)s) are simpler, often requiring only a debit to expense and credit to cash upon contribution.
Taxes: FICA/FUTA taxes are generally paid in the year of deferral, unless the amount is not yet vested.
For more details, see the OneAmerica Financial or GBQ CPAs articles.
Accounting For Deferred Compensation In The Present – GBQ
Jul 18, 2019 — An example of a nonqualified deferred compensation plan is a supplemental executive retirement plan (SERP). Accounting for it. The…
GBQ CPAs
How to Account for Deferred Compensation – wikiHow
Apr 29, 2025 — Set up the proper accounts. Whether you’re using accounting software or an old-school ledger, you’ll need to have the appropriate …
wikiHow
7.3 Accounting for deferred compensation plans – Viewpoint
Jun 15, 2024 — In certain deferred compensation arrangements, the liability is more akin to a long-term payable. For example, a deferred compensa…
PwC
Show all
Show more
Over 2.8 million + professionals use CFI to learn accounting, financial analysis, modeling and more. Unlock the essentials of corporate finance with our free resources and get an exclusive sneak peek at the first module of each course. Start Free
What is Deferred Compensation?
Deferred compensation refers to that part of one’s contribution that is withheld and paid at a future date. Retirement plans and employee pensions are examples of deferred compensation. Employers usually withhold a fraction of employees’ compensation every month, accumulate it over time, and pay the lump sum amount on a date previously agreed upon in the employment contract.
Since the compensation is paid at a later date, the amount deferred for payment is not included while computing tax. Therefore, it reduces the amount of taxable income in the current year. However, the requisite amount of tax is deducted at the time the employee receives this payment.
In some cases, employers invest the amount of deferred income into stock options or mutual funds. It increases the value of the payment due to the addition of interest payments and the possibility of capital gains.
Deferred compensations can be broadly classified into Qualified Deferred Compensation and Non-Qualified Deferred Compensation.
Summary
Deferred compensation refers to the part of one’s contribution that is withheld and paid at a future date.
Deferred compensation can be broadly classified into Qualified Deferred Compensation and Non-Qualified Deferred Compensation.
Since the compensation is paid at a later date, the amount deferred for payment is not included while computing tax. Therefore, it reduces the amount of taxable income in the current year.
Qualified Deferred Compensation
The Employee Retirement Income Security Act (ERISA), which was introduced to ensure protection to retirement assets, sets the rules for qualified deferred compensation. Under such rules, employees have a right to full information about their retirement plans free of cost. The law requires employee retirement assets to be held in a trust account.
The plans must be offered to all employees, and they are for the sole benefit of an employee. It means that creditors cannot claim the funds in case the company fails to pay its debts. Some examples of qualified deferred compensation include 401(k) and 403(b) plans.
ERISA also restricts the amount of money that can be deposited into a qualified plan. For example, the 401(k) plan limits the contribution of employees into the pension account at $19,500.
In general, qualified deferred compensation plans are governed by stricter rules, since the ERISA also specifies the minimum criteria that an employee must fulfill to qualify for the plan and includes extensive rules on how employers should provide sufficient funding for it.
Non-Qualified Deferred Compensation
Non-qualified deferred compensation plans (NQDC) evolved in response to the restrictions imposed on qualified deferred compensation plans by ERISA. The most distinguishing factor is that NQDCs have no maximum cap on the amount of employees’ contribution to their retirement savings account.
NQDCs are offered by companies to employees who earn high levels of income and wish to defer a greater portion of their income. The plans allow people to avoid taxes on a greater proportion of their earnings and enjoy higher tax-deferred investment returns.
Such plans are riskier compared to qualified deferred compensation plans since they are not protected under the rules of ERISA. NQDCs are not secured accounts, and the funds deposited in the plans can be taken over by the company’s creditors in case of default or bankruptcy.
Qualified vs. Non-Qualified Deferred Compensation Plans
The major points of difference between qualified deferred compensation and NQDC are as follows:
Benefits of Deferred Compensation Plans
Deferred compensation plans offer the following benefits to beneficiaries:
1. Security after retirement
Deferred compensation plans provide a stable income to people after they retire. The money received through retirement plans provides financial stability. Beneficiaries can also invest their money in mutual funds or other investment options later so that they can earn interest income.
2. Tax benefits
The portion of one’s income deferred for payment on a future date reduces current income and is not taxed until the beneficiary receives the payment. Individuals who expect to come under a lower income tax bracket in the future greatly benefit from the scheme. Moreover, in case future tax rates fall in the country, beneficiaries of deferred compensation plans will eventually pay less in taxes.
3. Capital gains
Many employers invest the funds deposited in deferred compensation accounts in mutual funds or other safe investment options that offer steady interest payments. Regular interest payments add to the value of the post-retirement payment. Moreover, if the value of the investment rises over time, the beneficiary stands to make capital gains as well.
Related Readings
CFI offers the Financial Modeling & Valuation Analyst (FMVA®) certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
Take your learning and productivity to the next level with our Premium Templates.
Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs.
Gain unlimited access to more than 250 productivity Templates, CFI’s full course catalog and accredited Certification Programs, hundreds of resources, expert reviews and support, the chance to work with real-world finance and research tools, and more.