Tax-deferred investments help you delay paying taxes when you file your return every year. Instead, you can bank the stipulated amount in the IRS-approved savings plan, allowing you to defer paying taxes until you’re ready to withdraw the amount, which is usually after retirement. If you’re looking for effective ways to postpone paying high taxes during your prime earning years, you must consider investing in tax-deferred investment accounts. Keep reading as we tell you more about how to mitigate your tax burden with legit investment savings. 

How Tax-Deferred Savings Work? 

Tax-deferred savings allow your investments to grow within the account, and you don’t have to pay taxes on your earnings annually, until the time you want to withdraw the amount from the investment account. This has a two-pronged benefit – firstly, it brings down your taxable income when you deposit a portion of your pre-tax income in an IRS-designated tax-deferred savings plan. Second, it helps you accrue profits, enabling you to reap benefits on your investment without having to pay tax on it. 

For example, you contribute $6,000 (max allowed in 2020 for those under 50 years of age) in an IRA account. If your investment grows 5% via appreciation and interests, your investment balance at the end of the year will tally up to $6,050. The benefit of an IRA is that you needn’t pay tax on the $50 you’ve earned in the current year. In this manner, your earnings continue to grow within the IRA, with the interest and the principal both working towards generating more wealth. However, do remember that many tax-deferring savings will penalize you if you withdraw the amount before you’re 59.5 years old. 

Tax-Deferred Account Types 

There are a variety of tax-deferred savings plans to choose from, the most popular ones being 401(k), 403(b) plans, traditional IRAs, Roth IRAs, and other tax-advantaged accounts such as Flexible Spending Accounts (FSAs), Health Savings Accounts (HSAs), 529 plans, etc. 

Annuities are other options to invest money to reduce taxes. Unlike 401(k)s and traditional IRAs, there’s no annual cap on how much you can invest in annuities. Your money compounds annually, without the profits being taxed. This means your investments work hard for you, growing your wealth while limiting the amount of taxes you pay. Do keep in mind, however, that if withdraw money from annuities before you’re 59.5 years old, you’ll incur a 10% penalty just like you’d do with a 401(K) or IRA. 

Benefits of Tax-Deferred Accounts 

If you’re in a high tax bracket right now, it’ll be wise to park a portion of your income in tax-deferred accounts, so that by the time you’re ready to withdraw them, you’ll most likely be in a lower tax bracket, which will automatically bring down the taxes you pay at the time of withdrawal. Moreover, tax-deferred accounts allow your wealth to grow, with no tax levied on the profit you acquire. Calculate your taxes here to get started with smart tax planning and investing for your future. Remember to diversify your investment portfolio with varied accounts and savings plans to take advantage of the tax-deferred investing options.

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