Layin’ It on the Line: What is tax deferral?
Tax deferral is a strategy in which you delay paying taxes on income until a later date. This can be achieved through investment in certain tax-deferred accounts. Your investment earnings grow tax-free in these accounts until you withdraw the funds. At that point, the withdrawals are taxed as ordinary income, typically at the time of retirement when you may be in a lower tax bracket. The goal of tax deferral is to reduce the amount of taxes paid over time and potentially increase your overall investment returns.
Tax deferral can be considered a form of tax management. By delaying the payment of taxes on income, tax deferral can help reduce your overall tax liability. Investing in tax-deferred accounts can increase your investment returns by allowing your earnings to grow tax-free. However, it’s essential to understand the rules and restrictions of each type of tax-deferred account and the tax implications of withdrawals to make informed decisions and effectively manage your taxes.
Tax deferral allows you to delay paying taxes on income until a later date. To benefit from tax deferral, consider the following steps:
1. Invest in tax-deferred accounts like IRAs, 401(k)s or annuities.
Investing in tax-deferred accounts like IRAs, 401(k)s or annuities can help benefit from tax deferral. Your investment earnings grow tax-free in these accounts until you withdraw the funds, typically in retirement. This allows you to defer paying taxes on your investment income until a later date when you may be in a lower tax bracket.
2. Delay taking income from tax-deferred accounts until retirement.
Delaying taking income from tax-deferred accounts until retirement can maximize tax deferral benefits. Withdrawals from tax-deferred accounts are taxed as ordinary income. It’s important to consider the age at which you will be required to take required minimum distributions (RMDs) from tax-deferred accounts, as well as your individual financial goals and needs.
3. Consider tax implications before making withdrawals from tax-deferred accounts.
Tax implications to consider are withdrawals from tax-deferred accounts. Withdrawals from tax-deferred accounts are taxed as ordinary income, so it’s important to understand how withdrawals will impact your overall tax situation. Factors such as your income, tax bracket and other sources of income should be considered when deciding when and how much to withdraw from tax-deferred accounts. Working with a financial advisor or tax professional can help you make informed decisions and minimize your tax liability.
4. Utilize strategies to minimize taxes on withdrawals, such as spreading out distributions over several years.
Yes, spreading out distributions over several years is one strategy to minimize taxes on withdrawals from tax-deferred accounts. By spreading out the withdrawals, you may be able to keep your taxable income in a lower bracket, thus reducing the amount of taxes owed. Other strategies to consider include converting traditional IRA funds to a Roth IRA or taking advantage of tax-free withdrawals for certain expenses, such as qualified higher education expenses or first-time home purchases. Understanding each strategy’s rules and restrictions is essential as well as working with a financial advisor or tax professional to develop a personalized plan to minimize taxes on your withdrawals.
Like all crucial decisions, consider asking for advice from a licensed and authorized professional.
Lyle Boss, a native Utahn, is a member of Syndicated Columnists, a national organization committed to a fully transparent approach to money management. Boss Financial, 955 Chambers St., Suite 250, Ogden, UT 84403. Telephone: 801-475-9400.