Investing Tax Free

Tax Deferred Investments

Tax deferred investments are not the same as tax free investments. Many people are confused by the term 'tax deferred investments' as opposed to tax free investments.

What are tax deferred investments?

The term 'tax deferred investments' is often used in conjunction with tax advantageous accounts such as retirement plan accounts, 401k, IRA, college savings accounts such as 529 or Coverdell Education IRA, annuities, and other qualified accounts.

The idea behind tax deferred investments is that the US government will not tax your investment earnings now but you will pay the taxes in the future when you withdraw some money.

For example, you put money in your Traditional IRA and you don’t pay any taxes on any investments gains until you withdraw some money out of your Traditional IRA.

The United States government has recognized that Social security benefits are declining and the cost of schools in rapidly increasing. To help you offset those costs, your absolute best weapon to fight them is tax deferred investments, which basically means not having to pay any taxes during the duration of growth, on money you put towards retirement or School funds.

Tax Deferred

The above chart demonstrates the advantages of Tax Deferral. The above amounts of tax deferred investments are for example only and do not represent actual performance of any tax deferred investments.

Even though tax deferred investments aren't exactly tax free investing, the benefit is still nothing to sneeze at! From the above example, The first person invests $100 a month at 8%, while the second invests the same amount, but tax deferred. After 40 years, the first has $190,713 but the second has a whopping $349,101 (Almost double what the other guy has) When the second investor takes the money out, she will be then be taxed, finally, since she invested ‘ tax deferred.' Still after taxation, he/she still ends up with $254,844. Which is still 50% more than the first guy has! Therefore, there is an obvious advantage of tax deferred investments.