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7.4 Voluntary deferred compensation arrangements
Publication date: 30 Jun 2022
us Pensions guide
Some deferred compensation agreements allow employees to elect to participate on a voluntary basis. A typical voluntary deferred compensation arrangement is funded by a company-owned life insurance policy and includes the following features:
- Individual employees voluntarily defer a portion of their annual compensation (e.g., $10,000)
- The employee receives fixed payments at specified future dates (e.g., $10,000 in each of years 7 through 10 after the deferral)
- In the event the employee terminates employment before the specified payment dates, the voluntary deferral plus interest accrued at a specified rate is received by the employee
- At the time an employee defers the compensation, the employer typically enters into a key person life insurance contract on the life of the employee, with the employer as the beneficiary
- The employer intends to meet the commitment to the employee by borrowing against the cash value of the policy
From the employee’s perspective, the arrangement may be attractive because the employee is able to defer the payment of tax on the compensation deferred. From the employer’s perspective, the cash compensation deferred is typically more than the insurance premium and the insurance proceeds are typically not taxable to the employer, making the arrangement attractive from a business standpoint, principally because the inflows equal or exceed the necessary deferred compensation payments.
The accounting for the employer’s liability to compensate the employee is unaffected by the employer’s decision to fund the arrangement using an insurance contract. The employer’s accounting for an investment in a "key-person" life insurance contract used to fund a deferred compensation agreement is discussed in LI 5.1.1.
The voluntarily deferred amount of compensation should be accrued as compensation expense in the period it is earned, which would ordinarily be the period in which the deferral election is made. The deferred compensation liability should be accreted by a charge to earnings throughout the term of the deferred compensation arrangement using the higher of the interest rate implicit in the arrangement or the specified interest-crediting rate.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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