What Is a Deferred Bonus Plan and How to Make Use of It

A deferred bonus is a compensation arrangement where an employee earns a bonus in one period but receives it later, typically after meeting certain conditions or milestones.

This incentive plan has caused debate in the HR industry due to worries about how well it aligns incentives and motivates employees, along with potential problems regarding employee satisfaction and understanding the delayed bonuses.

However, with the right tools and approach, you can transform this plan into a total lifesaver for your company. If you're considering using a delayed bonus plan, here's what you need to know about making it work for your business.

What is a deferred bonus plan?

A deferred bonus plan is a program offered by some employers, typically to high-performing or key employees, that allows them to delay receiving a portion of their bonus until later. This can be tax advantageous as they won't pay income tax on the money until it's paid out, and some plans may even offer investment options to grow the bonus amount over time.

Why do companies defer bonuses?

Companies defer bonuses to hold onto cash for short-term needs, to incentivize employees to stay with the company for a certain period to receive the full bonus, and to potentially offer tax advantages by delaying when the employee has to pay taxes on the money.

While deferring bonuses can benefit both the employer and the employee, some employees may prefer to receive cash immediately. Others might be concerned about the delay, especially if the company's financial situation is uncertain.

How do deferred bonus plans work?

Deferred bonus plans work by allowing companies to delay paying bonuses to employees. As mentioned above, this can be done for various reasons, such as conserving cash for short-term needs, encouraging employee retention, and potentially offering tax advantages.

Employees agree to delay receiving their bonuses for a set time, often in return for extra pay or tax benefits. The delayed incentives are usually paid later, either all at once or in parts, according to the plan's rules.

Here's a simple example of how a deferred bonus works: Imagine a company offers a delayed bonus plan. If employees receive a $10,000 bonus and decide to defer 25% for three years, they would set aside $2,500 each year. After three years, they would receive the $7,500 they deferred, plus any additional benefits the plan offers.

Deferred bonus vs deferred compensation plans

The difference between a delayed bonus and a deferred compensation plan is that a delayed bonus plan is typically based on performance, and an employee receives the bonuses at a future date, often to incentivize key employees to stay with the company.

On the other hand, qualified deferred compensation plans set aside an employee's taxable income to be paid out later, usually upon separation from the company or another predetermined event, or used as a retirement plan. The deferred income is typically invested, allowing it to grow over time, and may offer certain tax advantages. These plans are often based on deferred compensation agreements.

Pros and cons of deferred bonus plans

Delayed incentive plans can save employees money and reduce tax deduction, but it's important to consider their pros and cons, including potential risks and limitations.

Pros

• Save more than traditional plans: Employees can potentially save more money by letting the deferred portion of their bonuses grow over time.

• Flexibility in distribution: The plans offer flexibility in when and how the incentive bonus is paid out.

• Strategic tax planning: A highly compensation employee can plan their taxes better by deferring their bonus to a year with lower taxes.

Cons

• Employer risk: There's a risk that the employer may not be able to pay the bonus due to financial issues. So employees should have a risk tolerance.

• Loss of access: Highly compensated employees lose immediate access to the funds by deferring their bonus.

• Change in employer: Changing employers before receiving the bonus can result in losing the entitlement to it.

• Investment restrictions: These plans may have restrictions on how the bonus can be invested, affecting potential growth.

Use Competitive Pay Assessment to review your deferred bonus plans and maximize their benefits. This tool compares your bonuses to market standards and recommends adjustments based on your recruitment and retention goals.

Deferred bonus plan example and template

To give you an idea of what a deferred incentive bonus plan looks like, check out this template. Note: Use this as a starting point and customize it to fit your company's needs.

I. Introduction

This Deferred Bonus Plan ("Plan") is established by [Company Name] ("Company") to provide an incentive for qualified employees to achieve performance goals and contribute to the long-term success of the Company.

II. Eligibility

[Note: This section is critical. Decide which employees qualify. Will it be all employees, executives, or a specific department?]

Employees who meet the following criteria are eligible to participate in the Plan:

[List criteria, e.g., full-time employment for at least one year]

III. Participation

Participation in the Plan is voluntary. Eligible employees will be notified annually of the opportunity to defer a portion of their bonuses.

IV. Deferral of bonuses

High income earners or employees may elect to defer [percentage]% or [dollar amount] of their annual bonus. Deferral elections must be made in writing before [date].

V. Investment options

The bonuses will be invested in the following options:

[List investment options, e.g., a menu of mutual funds with varying risk profiles]

VI. Payment of bonuses

The bonuses will be paid to participants upon [Triggering Event: This could be retirement, termination, or a specific date].

VII. Administration

The Company shall appoint a Plan Administrator to oversee the operation of the Plan. The Administrator will be responsible for:

• Enrolling participants

• Processing deferral elections

• Investing deferred amounts

• Distributing benefits

VIII. Plan termination

The Company reserves the right to terminate the Plan at any time. In the event of termination, participants will be entitled to a full and final distribution of their vested account balances.

IX. Disclaimer

This Plan is provided for informational purposes only and does not constitute financial advice. The Company recommends that participants consult with a financial advisor before making any investment decisions.

X. Amendments

The Company reserves the right to amend the qualified Plan at any time.

How to make use of a deferred bonus plan

A well-designed delayed incentive plan can motivate and reward top employees for their long-term commitment and contributions to the company's success. Here's how to use it effectively:

1. Step 1: Define company's goals and target audience

   First, figure out why you want a deferred bonus plan. Is it for keeping important employees, encouraging better performance, or controlling finances? Then, decide who qualifies based on their job and what they bring to the company.

2. Step 2: Choose a plan type

   Choose the plan that fits your goals and employees best. Options include deferred cash bonuses, stock options, or retirement plans like a 401(k) match.

3. Step 3: Design the plan structure

   Create a clear plan with bonus amounts, deferral times, and any requirements or goals that must be achieved. It's wise to seek advice from legal and financial experts to ensure the plan follows regulations and is financially sound.

   Salary.com consultants can help design a structured deferred bonus plan. This includes setting contribution amounts, creating vesting schedules, and aligning the plan with company goals and performance metrics.

4. Step 4: Develop clear communication

   Tell eligible employees about the bonus plan in a clear and open way. Explain why it's happening, the perks of joining, and how it fits the company's goals. Let employees ask questions and get answers.

   With Consulting feature, achieving pay transparency and effective communication is easy. The consultants will help organizations communicate the bonus plan to all stakeholders.

5. Step 5: Monitor the plan and review

   Regularly check how well the delayed bonus plan works and its effect on employees. Review the plan, including the compensation package, now and then to ensure it's still effective and matches the organization's goals.

Using deferred bonuses can help retain your employees and encourage continued work, but ensure the plan is clear and well-organized, and takes other considerations into account. Explain how employees can earn the bonus, when they'll get it, and any requirements. After all, your goal is to prioritize the well-being of your employees to achieve mutual success—and you can achieve this with Salary.com Consulting services.