Orlando Harmon
Deferred compensation is a way for high-earning employees to delay paying taxes on their income beyond what they can do with a regular retirement plan. There are two main non-qualified deferred compensation plans that allow life insurance funding: supplemental executive retirement plans (SERPs) and corporate-owned life insurance (COLI). SERPs are similar to defined-benefit pension plans and give an employee a stated benefit provided by the employer at the time of retirement. With COLI, companies purchase life insurance policies on employees whom they wish to compensate. The company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire.
| Characteristics | Values |
|---|---|
| Definition | A non-qualified deferred compensation plan is a way for executives and other top-earning employees to delay taxes on income beyond what they can do with regular retirement plans |
| Who is it for? | Executives and other top-earning employees |
| Benefits | Employees can delay taxes while building future retirement income; employers are covered in case the key employee passes away; the company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire |
| Disadvantages | The assets are vulnerable if the employer goes bankrupt; creditors could take your deferred compensation funds |
| Examples | Supplemental executive retirement plans (SERPs); corporate-owned life insurance (COLI) |
What You'll Learn
Non-qualified deferred compensation plans
Deferred compensation plans are a way for executives and other top-earning employees to delay paying taxes on their income beyond what they can do with regular retirement plans. Life insurance is one way to fund these arrangements.
There are two main non-qualified deferred compensation plans that allow life insurance funding: supplemental executive retirement plans (SERPs) and corporate-owned life insurance (COLI). SERPs are similar to defined-benefit pension plans and give an employee a stated benefit provided by the employer at the time of retirement. With corporate-owned life insurance (COLI), companies purchase life insurance policies on employees whom they wish to compensate. The company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire.
The biggest disadvantage of these plans is that the assets are vulnerable if the employer goes bankrupt. Creditors could take your deferred compensation funds, whereas they couldn't take money from your 401(k). Another benefit of a deferred compensation plan using life insurance is that if the employee passes away, the policy covers the compensation at no loss to the employer.
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Supplemental executive retirement plans (SERPs)
Deferred compensation plans are a way for executives and other top-earning employees to delay taxes on income beyond what they can do with regular retirement plans. Life insurance is one way to fund these arrangements. With this system, employees can delay taxes while building future retirement income, and employers are covered in case the key employee passes away.
SERPs can be very effective in a low-interest environment. Another benefit is that if the employee passes away, the policy covers the compensation at no loss to the employer. However, the biggest disadvantage is that the assets are vulnerable if the employer goes bankrupt. Creditors could take your deferred compensation funds, whereas they couldn't take money from your 401(k).
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Corporate-owned life insurance (COLI)
Deferred compensation plans are a way for executives and other top-earning employees to delay taxes on income beyond what they can do with regular retirement plans. Life insurance is one way to fund these arrangements. With this system, employees can delay taxes while building future retirement income, and employers are covered in case the employee passes away.
There are two main non-qualified deferred compensation plans that allow life insurance funding: supplemental executive retirement plans (SERPs) and corporate-owned life insurance (COLI). SERPs are similar to defined-benefit pension plans and give an employee a stated benefit provided by the employer at the time of retirement.
With corporate-owned life insurance (COLI), companies purchase life insurance policies on employees whom they wish to compensate. The company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire. The biggest disadvantage is that the assets are vulnerable if the employer goes bankrupt. Creditors could take your deferred compensation funds, whereas they couldn't take money from your 401(k).
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Tax-deferred growth
Deferred compensation is a way for high-earning employees to delay paying taxes on their income beyond what they can do with a regular retirement plan. Life insurance is one way to fund these arrangements. With this system, employees can delay paying taxes while building their future retirement income, and employers are covered in case the employee passes away.
There are two main types of non-qualified deferred compensation plans that allow life insurance funding: supplemental executive retirement plans (SERPs) and corporate-owned life insurance (COLI). SERPs are similar to defined-benefit pension plans and give an employee a stated benefit provided by the employer at the time of retirement. With corporate-owned life insurance (COLI), companies purchase life insurance policies on employees whom they wish to compensate. The company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire. The biggest disadvantage is that the assets are vulnerable if the employer goes bankrupt.
Another benefit of a deferred compensation plan using life insurance is that if the employee passes away, the policy covers the compensation at no loss to the employer. When you are a business owner, you can choose to have a compensation arrangement with your employee that would pay their income at a later date. This is especially important if you are the sole proprietor of your company, as it ensures your family will be taken care of in case an unexpected event takes place.
In some life insurance products, you can take advantage of the tax-deferred growth provided by using an Index Universal Life IUL or a Variable Universal Life VUL. These can be very effective in the low-interest environment that we have seen in the last few years.
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Employer-owned life insurance
Deferred compensation is a way for high-earning employees to delay paying taxes on their income beyond what they can do with regular retirement plans. Life insurance is one way to fund these arrangements.
With a deferred compensation plan, employees can delay taxes while building future retirement income, and employers are covered in case the employee passes away. The employer signs a contract promising to pay the employee's earnings in the future.
There are two main non-qualified deferred compensation plans that allow life insurance funding: supplemental executive retirement plans (SERPs) and corporate-owned life insurance (COLI). SERPs are similar to defined-benefit pension plans and give an employee a stated benefit provided by the employer at the time of retirement. With COLI, companies purchase life insurance policies on employees whom they wish to compensate. The company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire. The biggest disadvantage is that the assets are vulnerable if the employer goes bankrupt.
Another benefit of a deferred compensation plan using life insurance is that if the employee passes away, the policy covers the compensation at no loss to the employer. When you are a business owner, you can choose to have a compensation arrangement with your employee that would pay their income at a later date.
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Frequently asked questions
A deferred compensation plan is a way for employees to delay taxes on income beyond what they can do with regular retirement plans.
Life insurance is one way to fund a deferred compensation plan. With this system, employees can delay taxes while building future retirement income, and employers are covered in case the employee passes away.
The two main types are supplemental executive retirement plans (SERPs) and corporate-owned life insurance (COLI). SERPs are similar to defined-benefit pension plans and give an employee a stated benefit provided by the employer at the time of retirement. With COLI, companies purchase life insurance policies on employees whom they wish to compensate.
One benefit is that if the employee passes away, the policy covers the compensation at no loss to the employer. Another benefit is that the employee can delay taxes while building future retirement income.
One disadvantage is that the assets are vulnerable if the employer goes bankrupt. Creditors could take your deferred compensation funds, whereas they couldn't take money from your 401(k).
