How Deferred Compensation Works for Retirement

Deferred compensation allows individuals to delay receiving part of their income until a future date, which often comes in retirement. This strategy is appealing for retirement savings and tax management, as this income is typically taxed at a lower rate when withdrawn. There are two types of deferred compensation: qualified deferred compensation plans and non-qualified deferred compensation (NQDC) plans. Each comes with its own rules, benefits and risks, which are important to understand.

If you want to plan your retirement, a financial advisor can recommend different savings, investment and tax strategies for your nest egg.

Understanding Deferred Compensation

Deferred compensation refers to an arrangement between an employer and an employee where a portion of the employee’s earnings is set aside to be paid at a future date. Employers may use these plans as a tool to attract and retain key talent, offering employees the ability to delay income until retirement or another predetermined time.

Certain types of deferred compensation, including stock options, can be used as part of an executive compensation plan. Other types of deferred compensation can be offered to a broader employee base, including 401(k) or 457 plans.

The primary appeal lies in the potential tax benefits, as the deferred earnings may be taxed at a lower rate when they are eventually distributed.

Qualified Deferred Compensation Plans

A qualified deferred compensation plan is a retirement savings plan that meets specific requirements outlined by the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code.

These plans are typically employer-sponsored, allowing employees to contribute a portion of their salary into a tax-advantaged account to grow their retirement savings. Contributions are usually made pre-tax, which helps lower your taxable income in the years you contribute.

Types of Qualified Deferred Compensation Plans

There are several types of qualified deferred compensation plans, each offering unique features.

401(k) plans: General employees
403(b) plans: Public school employees and certain non-profit organizations
457 plans: State and local government workers

Some plans may also offer employer-matching contributions, further boosting employee retirement savings.

Eligibility and Contribution Limits

Eligibility for qualified deferred compensation plans is generally broad, covering most employees at participating companies and workplaces. However, some plans may have restrictions based on years of service or job classification.

Contribution limits are regulated by the IRS, with 401(k) plans being one of the most common types. For 2025, the maximum employee contribution to a 401(k) or similar account is $23,500, with an additional $7,500 catch-up contribution allowed for those aged 50 or older. Eligible workers between ages 60 and 63 can make an enhanced catch-up contribution of up to $11,250.

However, these limits can vary, depending on the type of plan you choose.

Withdrawal Rules

Withdrawals from qualified deferred compensation plans are subject to specific rules set by the IRS. This typically includes traditional plans like 401(k)s and 403(b)s but not Roth accounts.

You can generally withdraw funds penalty-free starting at age 59 ½, but if you make withdrawals before this age, a 10% early withdrawal penalty applies, in addition to regular income tax. There are certain exceptions to this rule, including disability, certain medical expenses or separation from service after age 55.

Need help calculating RMDs from your qualified retirement plans? SmartAsset’s RMD calculator can help you estimate how much you’ll be required to withdraw and when.

Required Minimum Distribution (RMD) Calculator

Estimate your next RMD using your age, balance and expected returns.

Quickly estimate your RMDs and when to take them

RMD Amount for IRA(s)

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RMD Amount for 401(k) #1

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About This Calculator

This calculator estimates RMDs by dividing the user's prior year's Dec. 31 account balance by the IRS Distribution Period based on their age. Users can enter their birth year, prior-year balances and an expected annual return to estimate the timing and amount of future RMDs.

For IRAs (excluding Roth IRAs), users may combine balances and take the total RMD from one or more accounts. For 401(k)s and similar workplace plans*, RMDs must be calculated and taken separately from each account, so balances should be entered individually.

^*The IRS allows those with multiple 403(b) accounts to aggregate their balances and split their RMDs across these accounts.

Assumptions

This calculator assumes users have an RMD age of either 73 or 75. Users born between 1951 and 1959 are required to take their first RMD by April 1 of the year following their 73rd birthday. Users born in 1960 and later must take their first RMD by April 1 of the year following their 75th birthday.

This calculator uses the IRS Uniform Lifetime Table to estimate RMDs. This table generally applies to account owners age 73 or older whose spouse is either less than 10 years younger or not their sole primary beneficiary.

However, if a user's spouse is more than 10 years younger and is their sole primary beneficiary, the IRS Joint and Last Survivor Expectancy Table must be used instead. Likewise, if the user is the beneficiary of an inherited IRA or retirement account, RMDs must be calculated using the IRS Single Life Expectancy Table. In these cases, users will need to calculate their RMD manually or consult a finance professional.

For users already required to take an RMD for the current year, the calculator uses their account balance as of December 31 of the previous year to compute the RMD. For users who haven't yet reached RMD age, the calculator applies their expected annual rate of return to that same prior-year-end balance to project future balances, which are then used to estimate RMDs.

This RMD calculator uses the IRS Uniform Lifetime Table, but certain users may need to use a different IRS table depending on their beneficiary designation or marital status. It's the user's responsibility to confirm which table applies to their situation, and tables may be subject to change.

Actual results may vary based on individual circumstances, future account performance and changes in tax laws or IRS regulations. Estimates provided by this calculator do not guarantee future distribution amounts or account balances. Past performance is not indicative of future results.

SmartAsset.com does not provide legal, tax, accounting or financial advice (except for referring users to third-party advisers registered or chartered as fiduciaries ("Adviser(s)") with a regulatory body in the United States). Articles, opinions and tools are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. Users should consult their accountant, tax advisor or legal professional to address their particular situation.

Once individuals reach age 73 (75 for those born in 1960 or later), they must begin taking required minimum distributions (RMDs) each year. The amount of the RMD is based on the account balance and life expectancy. Failure to withdraw the correct RMD results in a hefty penalty of 25% on the amount that should have been withdrawn. The penalty drops to 10% if the RMD is corrected within two years.

These rules ensure individuals use the funds as intended, primarily for retirement income, and the government is able to tax it.

Non-Qualified Deferred Compensation Plans

A woman considering the benefits and drawbacks of a deferred compensation plan.

Non-qualified deferred compensation (NQDC) plans are a type of deferred compensation agreement primarily used by highly compensated executives and key employees. These plans allow individuals to defer a portion of their earnings to a future date, such as retirement, without the contribution limits imposed on qualified plans like 401(k)s.

Types of Non-Qualified Deferred Compensation Plans

There are several types of non-qualified deferred compensation plans.

Supplemental Executive Retirement Plans (SERPs)
Salary reduction agreements
Bonus deferral plans
Top-hat plans
Excess benefit plans

Because they’re non-qualified, these plans don’t meet the stringent requirements set by the Employee Retirement Income Security Act (ERISA). This gives employers more flexibility in offering these plans to select employees.

However, NQDCs also come with more risk for employees. If the company goes bankrupt, there are no protections in place to ensure employees receive their deferred compensation.

Who’s Eligible for Non-Qualified Deferred Compensation?

Due to their non-qualified status, eligibility for NQDC plans is typically limited to top-level employees, such as executives and highly skilled professionals. Unlike qualified plans, NQDCs aren’t available to rank-and-file employees, and there are no mandatory participation rules.

Tax Treatment

NQDC contributions aren’t immediately taxed. Instead, taxes are deferred until the compensation is paid out, often when the employee retires or leaves the company. They can also be deferred until a specified time period, such as 10 years.

At that point, the deferred income is taxed as ordinary income. This can provide potential tax advantages if you are in a lower tax bracket at this time.

Pros and Cons of Deferred Compensation

Deferred compensation plans offer both advantages and drawbacks that vary, depending on whether the plan is qualified or non-qualified.

Qualified deferred compensation plans, such as 401(k)s, follow strict IRS regulations. In comparison, non-qualified plans offer the opportunity to defer more money from taxes now, but you have no control over the funds until you eventually receive them.

Pros of Qualified Deferred Compensation

Tax advantages: Contributions to qualified plans are often tax-deferred, allowing for potential tax savings until the funds are withdrawn.
Employer matching: Many employers provide matching contributions, which can significantly increase the value of the plan over time.
Security: Assets in qualified plans are protected by federal law, guaranteeing compensation – even if the employer goes bankrupt.

Cons of Qualified Deferred Compensation

Contribution limits: The IRS imposes annual contribution limits, restricting the amount of income that can be deferred.
Required distributions: Many qualified plans mandate required minimum distributions (RMDs) to begin at age 73, which can complicate long-term financial planning.
Limited investment options: Investment choices may be restricted to a pre-selected list, potentially limiting growth opportunities.

Pros of Non-Qualified Deferred Compensation (NQDC)

No contribution limits: NQDC plans allow participants to defer larger amounts of income without being subject to IRS contribution caps.
Customizable terms: Employers and employees have more freedom to structure the terms of the NQDC plan, including payout schedules.
Tax deferral: Similar to qualified plans, NQDCs offer tax-deferred growth, potentially reducing tax obligations for employees in a lower tax bracket when they receive the income.

Cons of Non-Qualified Deferred Compensation (NQDC)

Creditor risk. Unlike qualified plans, NQDC assets aren’t protected from creditors if the company faces financial difficulties or bankruptcy.
Lack of portability: NQDC plans are often tied to the employer, making it difficult to transfer funds if the employee changes jobs.
Delayed access: Employees generally can’t access funds until a specific event occurs, such as retirement or separation from the company, limiting liquidity.

Bottom Line

An employee reviewing her retirement plan.

Deferred compensation enables individuals to set aside income to be paid at a later date, offering potential tax advantages and opportunities for retirement savings. Qualified plans, such as 401(k)s, are subject to IRS regulations, providing tax benefits, employer matching and legal protections. However, they also come with contribution limits and required distributions. Non-qualified plans, often used by executives, offer more flexibility with larger deferral amounts and customizable terms. However, they carry risks like lack of creditor protection and limited portability.

Tips for Retirement Planning

A financial advisor can help you create a retirement plan based on your needs, goals and risk profile. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to know how much your retirement savings could grow over time, SmartAsset’s free retirement calculator could help you get an estimate.