Tax Advisor Explains: Deferred Compensation Made Simple

When discussing retirement planning for employees, deferred compensation is an important topic. Both employers and employees should be fully informed about the terms and conditions of a deferred compensation agreement. The topic of deferred compensation is very broad and can be somewhat confusing. In this article, as tax advisors in Düsseldorf

and Oberhausen

, we will explain as simply and clearly as possible what deferred compensation is and how it can be implemented. However, it is still advisable to engage a qualified tax advisor to implement deferred compensation. A mistake in retirement planning might not be noticed until later and could lead to unpleasant surprises. Nevertheless, the following provides a good overview of deferred compensation.

What is deferred compensation?

Deferred compensation refers to a situation where an employee uses future earnings to fund a retirement plan. The basis for this is a deferred compensation agreement between the employer and the employee. This form of employer-sponsored retirement savings is subsidized by the government in Germany. The main advantage for employees lies in the savings on tax and social security contributions during their working years. The fact that company pensions will no longer be fully counted toward basic social security benefits in the future is an additional incentive. Within the framework of deferred compensation, there are various laws and regulations that make the agreement seem very complex to laypeople. An important legal basis is that every employee has a legal claim against the employer. This means that every employee has the right to use an agreed portion of their salary for the company pension plan.

How can deferred compensation be implemented?

There are various ways to implement deferred compensation. The primary distinction is between the “traditional” occupational pension plan (bAV) and the social partner model, or the “new” occupational pension plan. Below, we will briefly explain both implementation methods:

1. Traditional bAV

a) Employer’s unilateral right to determine the provider for insurance-based implementation methods

If the employer wishes to implement deferred compensation for their employees through direct insurance, a pension fund, or a pension plan, they have the right to determine the provider and may unilaterally select the pension provider for the employee. The employer may also determine the insurance plan, the benefit structure of the pension commitment, and the type of pension benefit. Under this implementation method, the employee has no option to request a different implementation method.

b) Employee’s right to direct insurance

If the employer does not specify a uniform deferred compensation plan through an insurance-based implementation method, the employee may take the initiative. The employee may request a direct insurance policy of their choice. Under this option, the employee must also specify the benefit structure. Consequently, employees must research many different providers and insurance options. This requires the employee to invest significant time and may necessitate professional assistance from a tax advisor.

c) Mutual agreement regarding direct commitment and support fund

If the employer and employee reach an agreement, deferred compensation can also be implemented through a direct commitment and a support fund. As a result, however, the employee must independently handle the administration and deferred compensation during both the funding phase and the payout phase. In most cases, support funds and life insurance companies also offer an administrative service that simplifies the deferred compensation process for the employee. This service typically involves a fee.

2. Social Partner Model – New Occupational Pension Plan

The new social partner model is similar in terms of deferred compensation. As with the traditional occupational pension plan, every employer has the unilateral right to set requirements if they opt for uniform implementation within the company. If no uniform deferred compensation is mandated, the employee may also request implementation through a selected direct insurance provider.

What should be considered in a deferred compensation agreement?

For a valid deferred compensation arrangement, a written deferred compensation agreement must be concluded between the employee and the employer. Under this agreement, the employee waives a portion of their gross pay. In return, the employer commits to converting these portions of the pay into occupational pension benefits. Furthermore, the key components of the deferred compensation arrangement are agreed upon. These include:

• the chosen implementation method
• the selected benefit structure
• Definition of the benefit objective (retirement, disability, and survivor benefits)
• the selected plan or pension scheme of the provider

Deferred compensation is possible for both regular compensation and one-time payments. It is also possible for the deferred compensation agreement to be regulated in a collective bargaining agreement and, under certain conditions, to be automatic. In this case, the employee must object to prevent the deferred compensation.

For simplicity’s sake, a fixed monthly amount can be set for regular deferred compensation. Additionally, annual maximum and minimum amounts can be established. This prevents, for example, ineffective minimum pensions. The minimum amount is based on the social security reference amount. The maximum amount can be limited to 4% of the contribution assessment ceiling.

What benefit goals can be achieved through deferred compensation?

In theory, three benefit goals can be achieved through deferred compensation. These include retirement planning, disability coverage, and survivor benefits. In practice, however, there are restrictions that are best discussed with a qualified tax advisor. Due to the complexity of the subject, we will not delve further into the specifics in this article.

What is the benefit structure?

Within the framework of deferred compensation, a benefit structure must be selected. The choice of benefit structure determines the amount of the promised pension benefit for which the employer is liable. It also determines whether the employer is obligated to adjust the current pension in the event of a claim. The different types and the scope of liability vary depending on the type of company pension plan. As tax advisors, we recommend that every employer seek detailed advice from qualified professionals to avoid mistakes. The scope of liability is an important issue for the protection of both employees and employers.

Financial Impact on the Employer

As a business owner, balance sheet implications are a key factor. The employer’s contributions to direct insurance, the pension fund, and the pension plan are business expenses. The same applies to contributions to the social partner model. The implementation channels and the support fund do not affect either the liabilities or the assets side of the company’s tax balance sheet. This also applies to the commercial balance sheet. In case of doubt, the matter should be discussed with a certified public accountant to avoid errors in the balance sheet.

Tax Questions – Help from a Qualified Tax Advisor

As tax advisors based in Düsseldorf and Oberhausen, we are the best point of contact for your tax matters. We look forward to helping you with any issues and answering any questions you may have. Thanks to our many years of experience, our team of experts can assist with any complex situation. Simply contact us to schedule a consultation. We look forward to your visit.