Tax deferment allows taxpayers to delay paying taxes on certain types of income or gains until a later date, typically when they expect to be in a lower tax bracket. Tax deferment is commonly associated with retirement accounts, such as 401(k) or Traditional IRA, where contributions grow tax-free until they are withdrawn in retirement.
Common examples of tax deferment include:
- Retirement accounts: Taxes on contributions and investment earnings are deferred until withdrawal.
- Real estate investments: Using Section 1031 exchanges to defer capital gains taxes when reinvesting in similar properties.
- Education savings accounts: Such as 529 plans, where earnings grow tax-free if used for qualified education expenses.
Tax deferment provides an opportunity to reduce current tax liability by postponing taxes to a future period when the taxpayer may be in a lower income bracket. However, taxpayers should be aware that deferred taxes are still due when the funds are accessed, and depending on the situation, they may face penalties for early withdrawal.