A guide to deferred compensation plans: Pros, cons and how they can work for you

July 31, 2025

George Yang

Career paths and timelines are changing. Gone are the days of people spending 30 to 40 years at the same company and retiring on the dot of 65. Today’s workforce is redefining how they work, how they live and how and when they get paid. Deferred compensation plans are a part of this work evolution, with increasing awareness of them as retirement planning vehicles, tax shelters for high-level executives and other financial opportunities for the Canadian workforce.

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What is a deferred compensation plan?

According to the Government of Canada, a prescribed salary deferral arrangement is a plan agreed upon between an employee and their employer where an employee postpones the receipt of salary and wages to a later fiscal year. The deferred compensation is not taxed until paid out, either during retirement or another arrangement. The deferred salary is then taxed and reported on the employee’s T4 statement in the year they receive the income (not the year they earn it in their job). Some people call a deferred compensation plan a long-term incentive program.

Note: Deferred compensation can be complex with many issues and it is recommended that all organizations and individuals seeking deferred compensation make all arrangements in writing to avoid misunderstandings between the employee and the employer and the proper allocations of income withholdings such as CPPIB and EI are applied at the correct time. This article is for informational purposes only and employees and employers should formalize any programs with financial and legal professionals before embarking on a deferred compensation plan.

Examples of deferred compensation are:

- Salary reduction arrangements to enable a future paid long-term leave or sabbatical;
- Pension plans;
- RRSP contributions;
- Retirement pensions;

Deferral of bonus payments; and
Stock options (including restricted stock options, an allocation of shares that comes with conditions).

” Before signing on the dotted line, it’s best to understand the pros and cons of embarking on a deferred compensation plan ”

The pros and cons of deferred compensation for the employee

Before signing on the dotted line, it’s best to understand the pros and cons of embarking on a deferred compensation plan. It is important to fully understand stock options and other deferred income agreements before exercising your options. Employees are best protected when deferred income is held in registered plans to protect their money.

Pros:

Employees may be able to lower their taxable income and enjoy the associated tax benefits right away;
Employees may be able to enjoy paid sabbaticals as part of their deferred compensation plan;
Deferred compensation can become a part of their retirement savings and overall wealth strategy (particularly during years with large bonuses and higher earnings); and
Some types of deferred compensation plans may have integrated asset protection.

Cons:

There can be limits on contributions that may impact your financial goals;
Loss of a portion of investments (depending on the type of investment) should the company go bankrupt or go out of business;
Lack of diversification of your stock portfolio (often due to having a high amount of your own company’s stock);
Limited flexibility in payout options (i.e., inability to access money that has been set aside if a financial emergency arises outside of the predetermined time that the deferred payment is scheduled for);
Loss of benefit or inflexibility in payout should you switch jobs; and
Risk involving changes in taxation laws.

The pros and cons of deferred compensation for the employer:

Pros:

Deferred compensation is a significant perk that can help attract and retain top-tier talent by offering more flexibility to take deferred leaves or reach financial goals;
Plans can be structured to be paid out after the business has sold or during key transition periods to ensure that important staff remain at the company long term; and
Firms may be able to grow a portion of compensation before it is paid out.

Cons:

Exercising deferred compensation plans involves a long-term financial commitment and the organization needs to ensure it will have the resources available to provide a payout on schedule;
Additional regulation, compliance and pension-related requirements under Canadian tax laws must be managed internally or outsourced to a pension provider; and
Deferred compensation agreements will need to be addressed directly as part of any mergers or acquisitions of the company to ensure financial commitments to employees are upheld.

Deferred compensation in practice

Michelle Carrillo is a secondary school teacher in Ontario who signed up for the deferred compensation program this past spring and will begin to have money deducted from her paycheques starting in September. She will receive a reduced paycheque for two years before taking a semester off work and receiving her deferred income.

Carrillo told HCM Dialogue that, as a teacher, she always knew deferred compensation was a possibility that she hoped to take advantage of.

Carrillo says that she and her husband are approaching their last five to six years of employment before retirement and “we wanted to split the time before retirement in half by taking half a year off to travel.” She adds, “We want to travel while we are still relatively young and healthy because we don’t know what the future holds. We have already dealt with some health challenges that were scary and made us think.”

She also notes that peak travel season coincides with times when teachers are traditionally off work and that deferred compensation allows for more travel at less cost.

She says that embarking on a deferred compensation plan and getting connected to the right people and paperwork to get answers and make things happen can be time-consuming. She emphasizes the importance of being vigilant, creating a detailed financial plan and connecting with other employees who have utilized deferred compensation to gain their insights.

Carrillo says deferred compensation is an excellent opportunity for people to try out retirement and enjoy life experiences without leaving the workforce or fully retiring.

Conclusion

Deferred compensation can offer many opportunities for employers and employees, whether in the form of a paid sabbatical or boost in retirement savings. However, like any other financial endeavour, everyone needs to clearly understand what’s required and how it will impact their finances today and in the future.

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