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Tax-Deferred Investment Account – What Is It?


In a tax-deferred investment account the dividends, interest and capital gains are not taxed until money is withdrawn. These kinds of investments are attractive to people whose earnings or net worth put them in a high tax bracket. They often expect they will be in a lower tax bracket when they retire. But people in high tax brackets aren’t the only ones who should consider tax-deferred investment accounts. Here’s an overview of some tax-deferred possibilities. Consider working with a financial advisor who can help you create a tax-efficient retirement plan. 

What Are Tax-Deferred Investments?

When you have a tax-deferred investment option, you have an account that allows you to postpone paying your federal income taxes. Instead of paying the taxes upfront, you can wait until you actually withdraw money from the account. As a result, any earnings you make from your contributions are also tax deferred. Further, some tax-deferred investment accounts also let you invest pre-tax dollars so neither your contributions nor any earnings are taxed until you start drawing on that money.

Certain tax-deferred accounts may carry early withdrawal fees, such as when you take out money before the age 59.5. When you take out money before the appropriate age of 59.5, you can be subject to a penalty tax of up to 10%.

These kinds of investment accounts differ from tax-free investment accounts. You still make contributions to a tax-free account, which receives the same benefits as the tax-deferred version. However, there is a major difference when it comes to retrieving the funds. With a tax-free investment, you don’t have to pay an income tax on any withdrawn funds. However, they also don’t give you any immediate tax benefits like you would find with an IRA or 401(k). You’ll typically find tax-free accounts in the form of Roth IRAs and plans with Roth features, such as Roth 401(k)s.

Types of Tax-Deferred Investments Accounts

There is more than one option of available investments when it comes to tax-deferred accounts. Some of the options you may encounter include:

Employer-Sponsored Retirement Plans

The type of employer-sponsored plan offered to you may vary. Some common types include 401(k)s or 403(b)s, which allow both tax-deferred compounding and pre-tax contributions.

Traditional and Roth IRAs

Depending on certain factors, such as your income level, you may be able to make pre-tax contributions to your traditional IRA. Alternatively, there are Roth IRAs, but they don’t allow for the same pre-tax status. Instead, they can be tax-free if you meet the right criteria.

Fixed Deferred and Variable Annuities

Senior Asian couple checks their investmentsAnnuities are insurance products. In exchange for purchasing an annuity contract, the insurer pays you, usually in regularly recurring sums. They can come in different forms but are broken into two categories: fixed and variable. Annuities provide you a death benefit and other possible guarantees, which may come under certain limitations. These are important tax-deferred investments for those who want to ensure their beneficiaries are protected after their death.

I Bonds or EE Bonds

Both Series I and Series EE savings bonds are low-risk saving products. They’re also non-marketable and interest-bearing, although they do hold some differences. For example, while they both have fixed rates, the Series I also includes a variable rate. The involved interest is tax-deferred for both of these bonds until you cash it in; however, it may be non-taxable if you use the funds for education.

Whole Life Insurance

Whole life insurance is a type of permanent life insurance, which means it lasts the entirety of your life. That is, it’s a lifetime policy as long as you pay your regular premiums. Part of these premium payments goes towards a cash value component. This cash value builds up over time without being taxed, making it tax-deferred.

Many people view their whole life insurance as a source of emergency funds thanks to the cash value. It grows quickly without taxes to cut it down, and the interest accrues.

Should I Invest in Tax-Deferred Investments?

Your personal situation and financial goals may help you determine if tax-deferred investments would help you. Since it depends on the individual, it’s worth investigating if you should allocate assets into one. In general, they are effective savings tools for those who have long-term goals.

So, if you are thinking about what your retirement savings might look like in the future, you have tax-deferred investments as an avenue. You can build on your investment and allow it to increase. Meanwhile, similar investments would subject you to annual taxes that can cut down on their growth.

While there are benefits to a tax-deferred account, they might not always be the right option. If you’re unsure whether they’ll work for you, speak to a financial professional. They can point you towards the investment strategy that will help you achieve your long-term financial goals.

The Bottom-line

Senior man standing in a streetWhile there is more to an investment strategy than the involved taxes, a deferred investment might be advantageous. They offer you the opportunity to build up your savings without worrying about the tax consequences. If you want to know more about these types of investments and find out whether they could work for you, consider speaking with a financial advisor. Their financial knowledge can help you work through your options. Additionally, they can guide you to the right investment strategy and find other ways to money loss outside of taxes.

Investing Tips

  • You want to make sure you’re on track with your long-term savings. That requires a solid knowledge of your current financial situation as well as what it might look like in the future. If you want a better idea of where you stand, try our cost of living calculator or our retirement calculator to get an estimate.
  • Tax-deferred investments may be a vital step in preparing for your retirement. But, juggling your accounts or planning out the finances for your long-term goal can come with its challenges. That’s why it might be time to look for a financial advisor. Looking for one doesn’t have to add to your stress, either. With SmartAsset’s matching tool, you can pair up with financial advisors in your area for free. If you’re ready to get your plan in order, get started now.

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