What is tax-deferred investment accounting?

The tax-deferred investment account is a savings account or investment option designed to allow you to avoid reporting the investment income earned within the account each year on your tax return if the funds remain in the account.

How does a tax-deferred investment account work?

Suppose you invested $1,000 in a tax-deferred savings account such as a 401(k) plan, IRA, or tax-deferred annuity. If the account value grows by 5% from the increased value of investments or interest income, you would have an account balance of $1,050 at the end of the year.

With this type of account, you do not have to claim $50 as investment income on your tax return for the current year. The $50 was earned inside a tax-deferred account or tax-deferred annuity.

The original amount of $1,000 and the new interest of $50 earn you more interest the following year. If the account grows by another 5% in the next year, you will receive $52.50 in tax-deferred earnings due to compounding interest.

This money is intended for use at retirement, which is why it can remain in the account tax-free. Withdrawing money from these accounts before age 59 and a half will incur a 10% penalty tax by the IRS. There are some exceptions, but that will depend on how you use the funds.

Types of tax-deferred accounts

You have several options for tax-deferred accounts. You can hold almost any investment within these accounts. Assets inside these accounts may include mutual funds, stocks, or bonds. They may also contain certificates of deposit and fixed or variable annuities. Accounts can include the following:

• Traditional retirement accounts.
• Retirement plans such as 401(k) plans, 403(b) plans, and 457 plans.
• Roth IRA accounts.
• Fixed tax-deferred annuities.
• Variable tax-deferred annuities.
• I Bonds or EE Bonds.
• Whole life insurance.

These are some common options for tax-deferred accounts. You can choose the account that fits your needs and financial goals.

Source: https://www.thebalancemoney.com/tax-deferred-savings-account-and-investments-2388988