Deferred compensation plans can give high-earning employees a way to set aside part of their pay now and receive it later, often after they retire. Unlike a 401(k), deferred compensation plans aren’t usually available to everyone at a company. They’re typically offered to executives, senior managers and other highly paid employees as another way to save for the future.
“Deferred compensation plans are typically designed for high earners, like executives, in order to allow them to push off receiving a portion of their compensation and instead receive that compensation with earnings at a later date,” says Jarred Wilson, vice president and consulting actuary at Segal, an employee benefits consulting firm in the New York City area.
Before participating in a deferred compensation plan, you’ll want to know:
— How deferred compensation plans work
— How deferred compensation plans compare with 401(k)s and IRAs
— The pros and cons of deferred compensation plans
— Whether a deferred compensation plan may be right for you
[READ: Your Guide to Retirement Planning.]
How Deferred Compensation Plans Work
A deferred compensation plan allows an employer to postpone a portion of an employee’s compensation until a specified date, which often occurs at or after retirement. Depending on the terms of the plan, “the lump sum owed to the employee is then paid out on that date or paid across a period of years after the specified date,” says Marco Sarkovich, an associate attorney at Porter Law Group Sacramento, California.
Unlike a 401(k), a deferred compensation plan generally doesn’t involve putting money into a separate, tax-qualified retirement account. Instead, you agree to receive part of your compensation at a later date, according to the terms of the plan. Generally, you don’t pay federal income taxes on the deferred compensation until you receive it, although Social Security and Medicare taxes generally apply earlier.
State income tax treatment of deferred compensation can vary depending on the states involved and the terms of the plan. “State income taxes are paid at distribution and are based on the state in which the income was earned, not the state in which the income is distributed,” Wilson says.
Unlike a 401(k), you aren’t making a deductible contribution to a deferred compensation plan. Instead, you agree to defer receiving a portion of your compensation. Because that income is deferred, you generally don’t pay federal income taxes on it until you receive the money. This can reduce your taxable income in the year you defer the compensation and potentially allow you to pay taxes on that income in a later year, when your tax rate may be lower. “When the funds are later withdrawn, savings are potentially realized through the difference between the retirement tax bracket and the tax bracket in the year the money was earned,” Sarkovich says.
Deferred Compensation Plans Versus 401(k)s and IRAs
Like a 401(k) or traditional IRA, deferred compensation can allow you to postpone paying income taxes on money you set aside for the future. You generally don’t pay federal income taxes on the deferred compensation until you receive it.
Unlike a 401(k) or traditional IRA, there are no contribution limits for a deferred compensation plan. The 401(k) plan contribution limits for 2026 are $24,500, or $32,500 if you are 50 or older. If you are 60 to 63 years old, you have a higher catch-up contribution limit of $11,250, and therefore can contribute up to $35,750. Traditional IRAs have a maximum contribution of $7,500 in 2026, or $8,600 if you are at least 50 years old. Since there are no limits on a deferred compensation plan, you could defer up to all of your annual bonus and set it aside as retirement income.
Another difference is when funds are distributed. For a 401(k) plan or IRA, you typically have to be at least 59 1/2 to take withdrawals without facing any penalty. “Many deferred compensation plans require you to make an upfront election of when you will receive the funds,” says Chris Kampitsis, a financial planner at Barnum Financial Group in Elmsford, New York. For example, you might time the payments to come at retirement or when a child is entering college. In addition, the funds could come all at once or in a series of payments.
[Read: What Is the Average Retirement Savings Balance by Age?]
Pros and Cons of Deferred Compensation Plans
A deferred compensation plan comes with several advantages over other retirement savings options. However, there are some potential drawbacks to consider. Reading through the details of a plan and talking to your employer can be useful as you evaluate your circumstances.
Pro: Ability to Set Dates
With a deferred compensation plan, you and your employer can decide on an optimal time for you to receive the funds. This may be helpful as you plan when you’ll retire and what income streams you’ll use to support your lifestyle.
Pro: Ability to Save
If you earn a high income, you might be looking for ways to set aside money beyond what you can contribute to traditional retirement accounts. You might decide to have $70,000 placed in the plan every year for 10 years. Because you generally don’t pay income taxes on the deferred compensation until it’s paid to you, you can defer taxes on that income during your working years.
Con: Higher Uncertainty
Getting a deferred compensation plan involves some risk since the funds belong to your employer until they are distributed. “In some situations, a plan may be designed to only pay out if the employee remains with the company until retirement, resulting in a forfeiture of the entire account balance for switching jobs,” Wilson says. If the company goes bankrupt, the balance in the account could be completely lost.
Con: Fewer Investment Options
The money in a deferred compensation plan is frequently placed directly into company stock. You might not have the choice of diversifying the investments. As the value of the company fluctuates, your built-up savings could go up and down too.
[Read: What Is a Mega Backdoor Roth?]
Should You Get a Deferred Compensation Plan?
It may be worthwhile to explore your investment options before signing on to a deferred compensation plan. You might find other areas to invest your income, such as real estate or a health savings account.
You may also review the company’s performance and assess its financial health. “If one has doubts as to the financial strength of the company, and if one may need to withdraw the money earlier than expected, a deferred compensation plan may not be an ideal option,” Sarkovich says.
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What Is a Deferred Compensation Plan? Pros, Cons and Advice for 2026 originally appeared on usnews.com
Update 08/18/26: This story was published at an earlier date and has been updated with new information.
