One way to put off paying the amount you owe in taxes is by deferring it. Tax deferral simply means putting off paying your tax till sometime later in the future when it is more favorable for you. When a taxpayer is said to have deferred their taxes, what it means is that they have put off the payment of their taxes until a later date in the future where it may be either taxed at a lower rate or deferred indefinitely.
A tax deferral works like this: the taxpayer puts the funds in a tax deferred account (such as an income account). This way, the funds are not taxable.
The taxpayer is not allowed to take out the money from the retirement account before the age of 59 and a half. The failure to stick to this rule and going ahead to withdraw money before the time is right will incur a penalty of 10 percent of the total amount that you have withdrawn.
When there is no tax due on the income end of an account, the account is said to be tax deferred.
Types of retirement accounts for individuals who want to get their tax deferred
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Solo 401(K) :
This is a type of retirement account under the 401(K).
People who own sole proprietor businesses have the liberty of creating their own 401(K) account and contributing to it as both an employer and an employee.
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401 (K)
This is a kind of retirement account that employers offer. It has two types; traditional and Roth.
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Simple IRA (“Savings Incentive Match Plan for Employees,” “Individual Retirement Account.”)
This kind of retirement account can only be used by small businesses, precisely employers who have 100 or fewer employees.
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SEP IRA (Simplified employee pension)
This kind of retirement account is employer-sponsored. It is simple to open and easy on the pocket. The contributions are made by the employees.
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Roth IRA
This is a special retirement account. It works perfectly for people who think their taxes will be higher at retirement than it is now.
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Individual Retirement Account (IRA)
This is a retirement account. It is different from the 401(K) in that it is opened by individuals and set up with a financial institution that will allow you to save for your retirement in a tax-free way.
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HSA (Health Savings Account)
This is another great place you can divert your funds to. A Health Savings Account allows you to keep money with them for health-related expenses and emergencies.
Benefits of having your tax deferred
Having your tax deferred is advantageous to you in two major ways.
- Your income is allowed to grow free of tax: When you have your tax deferred, it means that you will only pay taxes on those funds in the future. Your income is excluded from tax implications at the moment.
- You will eventually pay less tax: Another perk of having your tax deferred is hat most times, taxes are higher during working years, and lower during retirement. This automatically means that at retirement, when you eventually withdraw the funds and you need to pay your taxes, you will be paying less than you would have during your working years.
If the income tax bracket you anticipate to be taxed in the future is higher than the income tax bracket you are now, getting your tax deferred may not be a wise decision for you. It is not a one size fits all package. An individual’s unique tax situation must be considered before deciding whether or not to get his or her tax deferred.
Need help with tax deferral? Reach out to us today!
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