Annual compensation and annual salary may sound like the same thing but, in fact, they represent two very different measures of your earnings. Understanding what each of these terms means is important for determining how much money you earn on a yearly basis. In addition, it is essential to understand your annual compensation if you are saving for retirement in a tax-advantaged plan.
Annual Compensation Defined
Annual compensation, in the simplest terms, is the combination of your base salary and the value of any financial benefits your employer provides. This includes:
In most cases all the compensation you receive is considered taxable income by the Internal Revenue Service (IRS). There are some exceptions, however. For example, if you are a government employee working abroad and you receive a cost-of-living allowance, that income would typically be tax-free.
What Is Annual Salary?
Your annual salary is the amount of money your employer pays you over the course of a year in exchange for the work you perform. The salary you receive is based on a 40-hour work week, although (if you are on salary) your wages are not determined by the number of hours you work.
The federal government establishes base salary guidelines for certain employees including those working in executive, professional and administrative positions. Under old U.S. Department of Labor rules, the minimum base salary for these employees was $455 per week. Beginning December 1, 2016, the base salary rate was set to increase to $913 per week (see The New American Overtime Law), but in November 2016 a court case in Texas put that ruling on hold. (Read the details in Overtime Pay Rule Delayed.)
The purpose behind the rule is to ensure that salaried workers who work more than 40 hours per week are being adequately paid for their time. Hourly employees, by comparison, would receive an overtime wage that’s higher than their normal hourly rate for any hours they work beyond the initial 40-hour week. This wage has to be at least 1.5 times their regular hourly rate. (For more, see Salary vs. Hourly: How Benefits & Laws Differ.)
To figure out how much your salary breaks down to on an hourly basis, you divide the amount you receive over a particular pay period by the number of hours you work. For example, if you earn a salary of $72,000 annually and you work a 40-hour week all year. Before taxes, your salary breaks down to an hourly wage of $34.62.
How Annual Compensation Affects Retirement Savings
One of the reasons it is so important to understand your annual compensation is that certain retirement plans base your contribution limit on how much compensation you earn.
For example, consider a scenario where you are enrolled in your employer’s 401(k) plan, which offers a matching contribution of 50% of elective salary deferrals, up to 5% of your annual compensation. For 2018, the IRS caps the amount of annual compensation employers can use to determine matching contribution amounts at $270,000. Assume that your annual compensation totals $360,000 and you contribute the full $18,000 allowed for the year. Your employer would only be able to offer a match equal to half of 5% of $270,000, which comes to $5,000.
Knowing how much your employer is able to provide for the match is a must when you are mapping out your retirement strategy. The more money you can get from your employer, the faster your investments will grow over time. (For more, see 4 Ways to Maximize Your 401(k).)
The Bottom Line
It is easy to confuse annual salary with annual compensation, but knowing the difference can help you map out a clearer financial plan. Once you understand the total value of your employment, it is easier to determine how much you can defer into your employer’s retirement plan, what you will owe in taxes for the year and how much you’ll have left to cover your expenses. Not only that, but understanding what salary and compensation are can give you the edge when negotiating your pay for a new job or asking your current employer for a raise. (For more, see 7 Easy Steps to Negotiating a Raise.)