What Are Tax-Deferred Accounts? Everything You Need to Know

Tax-deferred accounts are investment accounts that allow you to postpone paying income taxes on the money you invest until it is withdrawn, typically in retirement. This tax deferral means your money can potentially grow faster than it would in a taxable account.

In this guide, you'll learn:

  • How tax-deferred accounts work
  • The benefits of tax-deferred accounts
  • Different types of tax-deferred accounts

Table of Content

A text image defining tax-deferred accounts as investment vehicles with tax-deferred growth until withdrawal in retirement.

Key Takeaway

Tax-deferred accounts offer a tax-advantaged way to grow your retirement savings faster.

How Tax-Deferred Accounts Work

When you contribute to a tax-deferred account, you may be able to deduct those contributions from your taxable income in the year you make them. This can lower your taxable income and, in turn, your tax bill for that year. The investments within the account then grow tax-free. You only pay taxes on your withdrawals, and those withdrawals are typically taxed as ordinary income.

Benefits of Tax-Deferred Accounts

Tax-deferred accounts offer several key benefits:

  • Tax-Deductible Contributions: Many tax-deferred accounts allow for tax-deductible contributions, lowering your current taxable income.
  • Tax-Deferred Growth: Investments within the account grow tax-free until withdrawn.
  • Potential for Faster Growth: Due to tax-deferred growth, your investments may grow faster than they would in a taxable account.
  • Retirement Savings: Tax-deferred accounts are designed to incentivize retirement savings.

Different Types of Tax-Deferred Accounts

There are several types of tax-deferred accounts available:

  • Traditional IRA (Individual Retirement Account): Available to anyone with earned income, subject to certain income limits.
  • Traditional 401(k): An employer-sponsored retirement plan.
  • 403(b): Similar to a 401(k) but designed for employees of non-profit organizations and public schools.
  • 457(b): Available to state and local government employees.

Which Tax-Deferred Account is Right for You?

The best tax-deferred account for you will depend on your individual circumstances, including your employment status, income level, and retirement goals. It's important to consult with a financial advisor to determine the best option for you.

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This guide has offered a comprehensive overview of tax-deferred accounts. For those seeking to deepen their understanding, we recommend exploring our guide on individual retirement accounts (IRAs), which dives into the different types of IRAs and their specific rules and benefits.

Tax Deferred FAQ

What are the benefits of a tax-deferred annuity?

Tax-deferred annuities offer tax-deferred growth, allowing your money to grow faster than it would in a taxable account. Additionally, they can provide guaranteed income in retirement.

Are tax-deferred accounts a good idea?

Tax-deferred accounts can be a good idea for those looking to save for retirement and reduce their current tax burden. However, it's important to consult with a financial advisor to determine if they are the right fit for your individual needs and goals.

What is the difference between tax-deferred and taxable?

In a tax-deferred account, you pay taxes on your investments when you withdraw them, typically in retirement. In a taxable account, you pay taxes on your investment gains each year.

What is an example of a tax-deferred investment?

Common examples of tax-deferred investments include Traditional IRAs, 401(k)s, 403(b)s, and 457(b) plans.