Tax Deferred

Tax deferred. A tax-deferred account allows you to postpone income tax that would otherwise be due on employment or investment earnings you hold in the account until some point the future, often when you retire.

For example, you can contribute pretax income to employer retirement plans, such as a traditional 401(k) or 403(b).

You owe no tax on any earnings in these plans, or in traditional individual retirement accounts (IRAs), fixed and variable annuities, and some insurance policies until you withdraw the money. Then tax is due on the amounts you take out, at the same rate you pay on your regular income.

A big advantage of tax deferral is that earnings may compound more quickly, since no money is being taken out of the account to pay taxes. But in return for postponing taxes, you agree to limited access to your money before you reach 59 1/2.

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Tax Deferred

What Does Tax Deferred Mean?

Refers to investment earnings such as interest, dividends, and capital gains that accumulate free from taxation until the investor withdraws and takes possession of them. The most common types of taxdeferred investments are those in individual retirement accounts (IRAs) and deferred annuities.

Investopedia explains Tax Deferred

By deferring taxes on the returns from an investment, the investor benefits in two ways. The first benefit is tax-free growth: Instead of paying tax on the returns from an investment, taxes are paid at a later date, allowing the investment to grow tax-free. The second benefit of tax deferral is that investments usually are made when a person is earning higher income and is taxed at a higher tax rate. By deferring withdrawals until later in life when his or her tax bracket may be lower, the investor is able to pay lower taxes on the income at that later time.

Related Terms:
• Capital Gain
• Qualified Retirement Account
• Roth IRA
• Traditional IRA
• Unrealized Gain