Meaning of Deferred Compensation

With deferred compensation (salary conversion), employees can pay into a company pension scheme and save on taxes and social security contributions. Employers are obliged to make this possible – they also save on wage taxes. If the employer grants a subsidy, the salary conversion is even more worthwhile. In the following, interested parties can find out whether and from when a deferred compensation in favor of a company pension or for leasing a company vehicle is worthwhile for you.

• The contributions to be paid during the savings phase are exempt from social security and tax, up to a specified maximum. In the disbursement phase, however, both social security contributions and taxes are due – in full.
• The higher the salary, the less savings the deferred payment offers.
• From 2022, according to the Company Pension Strengthening Act (BetrAVG), an employer contribution of 15 percent is mandatory for deferred compensation, provided that the employer can save social security contributions.

What is deferred compensation?

Anyone who opts for deferred earnings surrenders part of their gross monthly salary; in most cases the money goes into a company pension scheme. This is why the term gross deferred compensation is also used. The maximum amount of the deposit is set anew every year. The employer usually takes care of the pension provider and the contracts – salary conversion is particularly common with direct insurance, direct commitments or pension commitments. However, there are also other scenarios for which deferred compensation can be considered – for example for leasing a company vehicle. According to abbreviationfinder, DCP stands for Deferred Compensation Plan.

This is how salary conversion works for company pension schemes

The employer deducts the contributions for the company pension before taxes and social security contributions directly from the gross salary of the employee and pays them to the pension provider. This reduces the tax burden and the amount of social security contributions. The employee pays a higher amount into his company pension than he has less net cash available. The employer also benefits from this, as he also has to pay fewer taxes. The contributions to be paid during the savings phase are exempt from social security and tax, up to a specified maximum. In the disbursement phase, however, both social security contributions and taxes are due – in full.

Opting-in and opting-out models

Some employers use automatic salary conversion (opting-out model). In doing so, they deduct a fixed amount from the employee’s gross salary and pay it into the company pension scheme. Employees who do not want this would have to explicitly inform their employer.

Opting-in models do not provide for an automatic company pension. Here employees have to take action themselves and apply for a company pension, or they can ask their employer for a subsidy. This is usually necessary so that the salary conversion is worthwhile. For this reason, from 2022 employers must subsidize company pension schemes with 15 percent of the converted remuneration, provided they save social security contributions, in accordance with Section 1a (1a) BetrAVG.

When does deferred compensation make sense?

The company pension scheme through deferred compensation has both advantages and disadvantages. Interested parties should therefore carefully check whether this type of company pension is worthwhile for them. To do this, they calculate the savings compared to the case that they do not convert a salary, but only pay into the statutory pension insurance. In the case of deferred compensation, employees pay less into the statutory pension insurance due to the lower gross salary and accordingly have less money in old age. In order for the conversion to pay off, the company pension and savings in taxes and social security contributions must more than compensate for this loss.

The amount of the salary

High earners save less than average earners because they pay less taxes but still have to pay the maximum amount for health and long-term care insurance. Higher earners who are above the contribution assessment limit for statutory health insurance and who pay the maximum amount into statutory pension insurance can only save taxes on deferred earnings. In return, they receive a better statutory pension.

Employer subsidy and change of employer

As a rule, company pension schemes through deferred compensation are only worthwhile with a subsidy from the employer. Otherwise, depending on the income and amount paid in, the employee would often have to live to be over 100 years old in order to get his contributions out again.

With an employer contribution of at least 15 percent, the company pension with salary conversion is worthwhile – but only if employees do not change jobs frequently or switch back and forth between employee status and self-employment. Because it is not so easy to take the old contract with you to the new employer. Employees then either have several contracts in parallel or pay closing costs for the transfer of the old to the new contract each time they change employers.

Benefits of deferred compensation

If you give up part of your gross salary as part of a deferred compensation and invest in company pension schemes, you lower your gross salary – which in turn results in lower taxes and social security contributions. In addition, he pays more into the company pension than he has less net income. Contracts for a company pension are usually cheaper than a private pension. From 2022, employers must grant a subsidy of at least 15 percent of the remuneration assigned.

Disadvantages of salary conversion

As a result of the conversion of gross earnings, employees lose part of the statutory pension, as they also pay lower pension insurance contributions due to the reduced gross salary. If you receive the company pension as a pensioner, you pay the full amount of the statutory health and long-term care insurance. Without a subsidy from the employer, company pension insurance through deferred compensation is rarely worthwhile. Those who change jobs frequently also hardly benefit from company pension schemes.

Salary conversion for leasing

Anyone who needs or wants a company car for their work can finance it, just like the company pension scheme, through deferred compensation. This is also worthwhile for the employer: he usually does not incur any costs and he can bind his employees more closely to the company with so-called company car leasing. This variant is also suitable for a salary negotiation: A salary increase can also take place in the form of a company car financed through salary conversion. Most of the time, the employee is allowed to use the vehicle for private purposes.