Tax-deferred refers to a financial arrangement or investment account where taxes on income, gains, or contributions are postponed until a later date. In a tax-deferred account, such as a retirement account or certain annuities, individuals can contribute pre-tax income or make tax-deductible contributions, allowing them to defer paying taxes on that income until they withdraw the funds in the future.
Contributions made to tax-deferred accounts are typically made with pre-tax income, meaning they are deducted from the individual's taxable income for the year. The investment earnings and capital gains generated within a tax-deferred account can grow and compound over time, allowing the investments to potentially grow faster than if they were subject to annual taxation.
While taxes are deferred, they are not waived entirely. Individuals will eventually have to pay taxes on the contributions and earnings when they withdraw the funds from the tax-deferred account. Withdrawals are typically subject to income tax at the individual's tax rate at the time of withdrawal.
Tax-deferred accounts are commonly associated with retirement savings like Traditional IRAs, 401(k) plans, 403(b) plans, and deferred annuities. The tax-deferred status is maintained until a certain age, typically 72 years old. At that point, individuals are required to start taking withdrawals, known as Required Minimum Distributions (RMDs), and pay taxes on those distributions. However, tax-deferred arrangements can also apply to other financial products or investments, such as certain annuities or specific educational savings accounts like 529 plans.