Advice From Labib: What Is Tax Deferral?
Advice From Labib
What Is Tax Deferral?
"Tax deferral" is a method of postponing the payment of income tax on currently earned investment income until the investor withdraws funds from the account. Tax deferral is encouraged by the government to stimulate long-term saving and investment, especially for retirement.
Only investment vehicles designated as "tax deferred," such as IRAs, Keogh plans, and 401(k)s, allow taxes to be deferred. In addition, many insurance-related vehicles, such as deferred annuities and certain life insurance contracts, provide tax-deferred benefits.
There is a substantial benefit to deferring taxes as long as possible, because this allows the entire principal and any accumulated earnings to compound tax deferred. The compounding effect can be dramatic over an extended period of time and can make a big difference in the accumulation of a retirement nest egg.
Additionally, tax-deferred investments are often made when you are earning a higher income and are therefore taxed at a higher rate. When you reach retirement and begin taking distributions from your tax-deferred accounts, there is the possibility that you will be in a lower tax bracket.
One note of caution: When formulating your tax plan, recognize that most tax-deferred investments do incur penalties for early withdrawals prior to age 591/2. All withdrawals are subject to ordinary income tax, but early withdrawals are subject to an additional 10% federal income tax penalty. Once again, the government is encouraging a long-term outlook.
Alfred Labib is an Independent Financial Advisor. "Our Goal Is To Help Investors Grow And Preserve Their Wealth Through Discipline And Process." 301-766-2039, www.labibfinancial.com.