The idea behind tax-deferred retirement investments is a fairly simple yet powerful one. When money is placed in a tax-deferred vehicle no federal taxes are due on it until the funds are taken out. That means money invested in such vehicles will not have to be reported on your tax return.
This reduces your taxable income and allows you to save up more retirement. The concept is fairly simple but the reality is actually much more complicated because of the wide variety of such investments out there.
Tax-Deferred Retirement Plans
The most common of these investments is a retirement plan. In the common arrangement a person puts a set amount of money a year into the plan. The funds are then invested in something like a mutual fund. Any gains from the investment are reinvested in the plan to increase its value. This takes advantage of the principle of compound interest.
Examples of this kind of arrangement include IRAs, Keogh plans and 401K plans. If this scheme is part of a compensation package, an employer may match the employee’s contributions. Not every such plan is tax deferred, in a Roth IRA or Roth 401k taxes are paid on the contributions when they are made. In exchange for this no taxes will be due on the money in the future.
It should be noted that there are a wide variety of tax-deferred retirement plans available. Some of these plans are only open to people in certain professions such as government employees and school teachers. The rules for these plans can different so you should check with the IRS before not declaring any plan on your tax return.
The big drawback to such plans is that the amount of money a person can sock away in one is usually limited. Most such plans limit investment to a percentage of a person’s income or to a few thousand dollars a year.
Limitation to Tax-Deferment
Most tax-deferred investments come with a big limitation under IRS rules that you should be aware. A person that takes money out of a retirement plan or annuity before they reach age 59½ will be charged an additional 10% tax penalty. They will have to pay their normal taxes on money and an additional 10%.
That is why it is not a good idea for persons under 45 to put a lot of money in tax-deferred plans or annuities. Many people would be better served by placing funds in a traditional vehicle such as a mutual fund or money market and waiting until they reach their fifties before putting fund in tax-deferred instruments. There are some vehicles designed for this including fixed-annuities.
There are some tax deferred-vehicles not subject to this penalty. They include Tax Sheltered Annuities or 403B plans. Unfortunately those investments are only available to certain people such as public school teachers.
Tax Deferred Annuities
Many people are not aware of it but both annuities and insurance policies are considered tax-deferred investments by the IRS. That means that funds placed in these vehicles will not have to be reported on your income tax return. The big advantage to annuities is that there is no limit to the amount of tax-deferred income a person can put in one. They are also insured so funds in one are far less likely to be lost than money in a retirement account.
Rollover or 1031 Exchange
Many people seem to believe that funds cannot be taken out of tax-deferred investments. This is simply not true section 1031 of the IRS code allows you to rollover or transfer funds from one deferred vehicle to another. The only restriction is that the funds have to stay in a deferred product. If they move into anything else such as a bank account they become taxable income. That means a person could move funds from an IRA into an annuity.
This reduces your taxable income and allows you to save up more retirement. The concept is fairly simple but the reality is actually much more complicated because of the wide variety of such investments out there.
Tax-Deferred Retirement Plans
The most common of these investments is a retirement plan. In the common arrangement a person puts a set amount of money a year into the plan. The funds are then invested in something like a mutual fund. Any gains from the investment are reinvested in the plan to increase its value. This takes advantage of the principle of compound interest.
Examples of this kind of arrangement include IRAs, Keogh plans and 401K plans. If this scheme is part of a compensation package, an employer may match the employee’s contributions. Not every such plan is tax deferred, in a Roth IRA or Roth 401k taxes are paid on the contributions when they are made. In exchange for this no taxes will be due on the money in the future.
It should be noted that there are a wide variety of tax-deferred retirement plans available. Some of these plans are only open to people in certain professions such as government employees and school teachers. The rules for these plans can different so you should check with the IRS before not declaring any plan on your tax return.
The big drawback to such plans is that the amount of money a person can sock away in one is usually limited. Most such plans limit investment to a percentage of a person’s income or to a few thousand dollars a year.
Limitation to Tax-Deferment
Most tax-deferred investments come with a big limitation under IRS rules that you should be aware. A person that takes money out of a retirement plan or annuity before they reach age 59½ will be charged an additional 10% tax penalty. They will have to pay their normal taxes on money and an additional 10%.
That is why it is not a good idea for persons under 45 to put a lot of money in tax-deferred plans or annuities. Many people would be better served by placing funds in a traditional vehicle such as a mutual fund or money market and waiting until they reach their fifties before putting fund in tax-deferred instruments. There are some vehicles designed for this including fixed-annuities.
There are some tax deferred-vehicles not subject to this penalty. They include Tax Sheltered Annuities or 403B plans. Unfortunately those investments are only available to certain people such as public school teachers.
Tax Deferred Annuities
Many people are not aware of it but both annuities and insurance policies are considered tax-deferred investments by the IRS. That means that funds placed in these vehicles will not have to be reported on your income tax return. The big advantage to annuities is that there is no limit to the amount of tax-deferred income a person can put in one. They are also insured so funds in one are far less likely to be lost than money in a retirement account.
Rollover or 1031 Exchange
Many people seem to believe that funds cannot be taken out of tax-deferred investments. This is simply not true section 1031 of the IRS code allows you to rollover or transfer funds from one deferred vehicle to another. The only restriction is that the funds have to stay in a deferred product. If they move into anything else such as a bank account they become taxable income. That means a person could move funds from an IRA into an annuity.
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