Deferred accounts are financial instruments that allow individuals or organizations to postpone the taxation of contributions, earnings, or payouts to a future date. These accounts are commonly used in retirement planning and offer the advantage of growing investments tax-deferred until withdrawals are made, usually during retirement.
Types of Deferred Accounts
Individual Retirement Account (IRA)
An Individual Retirement Account (IRA) is a tax-advantaged retirement savings plan available to individuals. Contributions can be tax-deductible, and investment earnings grow tax-deferred.
Keogh Plan
The Keogh Plan, also known as an HR10 plan, is a tax-deferred pension plan tailored for self-employed individuals and unincorporated businesses. Similar to IRAs, contributions are tax-deductible, and earnings grow tax-deferred.
Profit-Sharing Plan
A Profit-Sharing Plan is a retirement plan that allows employers to share profits with employees. Contributions are tax-deductible for the employer, and the funds in the plan grow tax-deferred until withdrawal by employees.
Salary Reduction Plan (SEP-IRA)
A Salary Reduction Simplified Employee Pension Plan (SEP-IRA) is a retirement plan that allows employers to make contributions to individual retirement accounts (IRAs) set up for employees. Contributions are tax-deductible for the employer, and investment earnings are tax-deferred.
Special Considerations
Tax Deferral Benefits
Deferred accounts help individuals reduce their current taxable income, leading to potential tax savings. This allows investments to grow over time without being diminished by annual taxes on earnings.
Contribution Limits
Each type of deferred account has specific contribution limits set by the IRS, which can affect the amount you can defer each year. For instance, in 2024, the contribution limit for IRAs is $6,500 ($7,500 if over age 50).
Historical Context
The concept of tax-deferred accounts gained prominence with the establishment of IRAs under the Employee Retirement Income Security Act (ERISA) in 1974. Other plans like SEP-IRAs and Keogh Plans were introduced to provide more tailored options for different types of workers.
Applicability
Retirement Planning
Deferred accounts are a cornerstone of retirement planning, providing a structured way to save for retirement with tax advantages.
Small Business
Plans like SEP-IRAs and Keogh Plans are particularly beneficial for small business owners and self-employed individuals to maximize their retirement savings with tax benefits.
Comparisons
Roth IRA vs. Traditional IRA
While both Traditional IRAs and Roth IRAs offer tax advantages, a Traditional IRA allows for tax-deferred growth, whereas Roth IRAs provide tax-free growth but contributions are made with after-tax income.
Related Terms
- 401(k) Plan: A 401(k) plan is an employer-sponsored retirement savings plan that lets workers save and invest a portion of their paycheck before taxes are taken out. Contributions and earnings are tax-deferred.
- Tax-Deferred Annuity: A Tax-Deferred Annuity is a financial product that allows for the deferral of income taxes on earnings until the income is withdrawn, often used as a retirement savings vehicle.
FAQs
What are the penalties for early withdrawal from a deferred account?
Can I have multiple deferred accounts?
How do required minimum distributions (RMDs) work?
References
- Internal Revenue Service (IRS) - Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).
- U.S. Department of Labor - Understanding Retirement Plans.
- Financial Industry Regulatory Authority (FINRA) - Types of Retirement Accounts.
Summary
Deferred accounts offer significant tax advantages by allowing contributions and earnings to grow tax-deferred until retirement. They play a vital role in retirement planning, helping individuals and businesses maximize savings while managing tax liabilities effectively. Understanding the different types of deferred accounts and their respective rules is essential for leveraging their benefits to achieve long-term financial goals.
