DEFERRED COMPENSATION PLANS
A deferred compensation plan is a contract between an employee and an employer. Under the contract, the employee agrees to defer the receipt of money owed to the employee from the employer until after the employee retires. After retirement, the employee will traditionally be in a lower tax bracket and will be able to keep a larger percentage of the money. Deferred compensation plans are traditionally unfunded and, if the corporation goes out of business, the employee becomes a creditor of the corporation and may lose all of the money due under the contract. The employee may only claim the assets if they retire or become disabled; or, in the case of death, their beneficiaries may claim the money owed. Money due under a deferred compensation plan is paid out of the corporation's working funds when the employee or their estate claims the assets. Should the employee leave the corporation and go to work for a competing company, they may lose the money owed under a non-compete clause. Money owed to the employee under a deferred compensation agreement is traditionally not invested for the benefit of the employee, and as a result, does not increase in value over time. The only product that traditionally is placed in a deferred compensation plan is a term life policy. In the case of the employee's death, the term life policy will pay the employee's estate the money owed under the contract.
All qualified corporate plans must be in writing and setup as a trust. A trustee or plan administrator will be appointed for the benefit of all plan holders.
TYPES OF PLANS
There are two main types of qualified corporate plans: a defined benefit plan and a defined contribution plan.
DEFINED BENEFIT PLAN
A defined benefit plan is designed to offer the participant a retirement benefit that is known or "defined." Most defined benefit plans are set up to provide employees with a fixed percentage of their salary during their retirement such as 74 percent of their average earnings during their five highest paid years. Other defined benefit plans are structured to pay participants a fixed sum of money for life. Defined benefit plans require the services of an actuary to determine the employer's contribution to the plan based on the participant's life expectancy and benefits promised.