Tax-Deferred
Quick Definition
An investment or account where taxes on earnings are postponed until funds are withdrawn, typically in retirement.
Key Takeaways
- Tax-deferred accounts let investments grow without annual tax drag
- Contributions reduce current taxable income; withdrawals are taxed as ordinary income
- Most beneficial when your retirement tax bracket will be lower than your current bracket
- RMDs force withdrawals starting at age 73 — plan for the tax impact
What Is Tax-Deferred?
Tax-deferred refers to investment accounts and arrangements where income taxes on contributions and/or investment gains are postponed until the money is withdrawn, typically during retirement when the account holder may be in a lower tax bracket. The primary tax-deferred accounts include traditional 401(k)s, traditional IRAs, 403(b)s, 457 plans, and certain annuities. Contributions to these accounts often reduce current taxable income, and all investment growth (dividends, capital gains, interest) compounds without annual taxation — a powerful advantage over taxable accounts. However, all withdrawals are taxed as ordinary income, and required minimum distributions (RMDs) begin at age 73. The tax-deferred strategy is most beneficial when the investor expects to be in a lower tax bracket during retirement.
Tax-Deferred Example
- 1Contributing $24,500 to a traditional 401(k) at a 24% marginal rate reduces current federal taxes by $5,880.
- 2$100,000 invested tax-deferred at 8% for 30 years grows to $1,006,000 vs. $761,000 in a taxable account (assuming 24% annual tax on gains).
- 3A retiree in the 12% bracket withdrawing from a tax-deferred account pays far less than the 24% bracket they were in when contributing.
Related Terms
Traditional IRA
A tax-advantaged individual retirement account where contributions may be tax-deductible and earnings grow tax-deferred.
Required Minimum Distribution (RMD)
The minimum amount that must be withdrawn annually from tax-deferred retirement accounts starting at age 73.
Qualified Distribution
A withdrawal from a tax-advantaged retirement account that meets IRS requirements and avoids penalties.
Marginal Tax Rate
The tax rate applied to the last dollar of income earned, determined by the taxpayer's tax bracket.
FAFSA (Free Application for Federal Student Aid)
The federal form used to determine eligibility for financial aid including grants, loans, and work-study programs.
401(k)
An employer-sponsored retirement savings plan with tax advantages, often including employer matching contributions.
Expand Your Financial Vocabulary
Explore 130+ financial terms with definitions, examples, and formulas
Browse Personal Finance Terms