Retirement Planning

Understanding Tax Deferral

When you're planning for retirement, you hear a lot about tax-deferred accounts and compounding interest. But what exactly does that mean? Find out here.

Retirement Accounts: What Does Tax Deferred Mean and What Are The Advantages?

The term tax-deferred simply means that you'll pay taxes at a later date. Investment accounts that are considered tax deferred typically include traditional and Roth IRAs, SEP IRAs, and 401ks. In addition, many insurance company products, such as deferred annuities and certain life insurance policies, may also provide tax-deferred benefits.

The power of compounding

When it comes to retirement planning, retirement accounts that are tax-deferred can have a big impact on your retirement savings, by allowing your money to grow quicker than if it were in a taxable investment account. How? With a process called compounding.

In the context of tax deferral, compounding allows for interest and dividend payments to be unencumbered by taxes until withdrawn at a later date.  Ideally, this occurs years in the future. This can allow for more efficient growth of your contributions than would have been experienced had those same dividend and interest payments been subject to tax at the time they were originally received.

Moreover, contributions in your tax-deferred accounts are often made when you're earning a higher income and typically subject to a higher tax rate. So when it comes time to retire and begin drawing income (distributions) from your tax-deferred accounts, you may find yourself in a lower tax bracket and paying less income tax on your withdrawal than you would have when you originally invested your money.

For more information on improving your retirement planning knowhow, visit the Protective Learning Center.

Disclaimer: The information in this article is not intended to be tax or legal advice and should not be relied on for the purpose of avoiding any federal tax penalties. Please consult with a qualified tax professional or consult with a professional financial advisor.

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All Learning Center articles are general summaries that can be used when considering your financial future at various life stages. The information presented is for educational purposes and is meant to supplement other information specific to your situation. It is not intended as investment advice and does not necessarily represent the opinion of Protective Life or its subsidiaries.

Learning Center articles may describe services and financial products not offered by Protective Life or its subsidiaries. Descriptions of financial products contained in Learning Center articles are not intended to represent those offered by Protective Life or its subsidiaries.

Neither Protective Life nor its representatives offer legal or tax advice. We encourage you to consult with your financial adviser and legal or tax adviser regarding your individual situations before making investment, social security, retirement planning, and tax‐related decisions. For information about Protective Life and its products and services, visit www.protective.com.

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