Written by What Is Tax-Deferred Growth?
- Definition: Tax-deferred growth means you don’t have to pay taxes on the investment gains—such as interest, dividends, or capital gains—until you withdraw the money.
- How It Works: Investments grow without being taxed during the accumulation phase. Taxes are only paid upon withdrawal, typically in retirement.
Tax-Deferred Accounts
- 401(k) and Traditional IRA: Contributions to these accounts are typically tax-deductible, and the investment grows without incurring taxes until withdrawals are made.
- Deferred Annuities: Deferred annuities also offer tax-deferred growth. The interest earned on the annuity’s balance is not taxed until you begin receiving payouts.
- Tax-Deferred vs. Tax-Free: With tax-deferred growth, you’ll still pay taxes upon withdrawal, whereas with tax-free growth (as seen with Roth IRAs), no taxes are due on withdrawals if certain conditions are met.
Why Tax-Deferred Growth Is Beneficial
- Compounding Interest: Tax-deferred growth allows you to compound your earnings without losing a portion of your returns to taxes each year, leading to larger long-term gains.
- Delaying Taxes: By delaying taxes, you can invest more upfront, potentially leading to greater future growth.
Important Considerations
- Withdrawal Rules: Tax-deferred accounts come with specific withdrawal rules. Withdrawing funds before retirement age may incur penalties and taxes on the withdrawal amount.
- Required Minimum Distributions (RMDs): Once you reach a certain age (typically 72), you must begin taking minimum distributions from tax-deferred retirement accounts.
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