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Navigating the Complexities of Tax-Deferred Accounts

Navigating the Complexities of Tax-Deferred Accounts

October 10, 2023

Tax-deferred accounts are just one of several options that can help you improve your savings for the future. Difficulty in understanding the complexities inherent to these types of accounts keeps many from taking full advantage of the financial perks of a tax-deferred account. Maximize your savings and future financial security by making the best use of the advantages these accounts have to offer. 

If you have been thinking about how you can make the most of your savings, here is what you need to know about tax-deferred accounts.

How Tax-Deferred Accounts Work

A tax-deferred account is a common vehicle to help you achieve your savings goals and compound the growth in your investment accounts. The way it works is quite simple: you contribute funds to certain types of accounts using your pre-tax dollars. This allows you to contribute more money into the account and taxes are paid when you withdraw the funds later down the road. 

Keep in mind that a tax-deferred account is different from a tax-exempt account which does not require you to pay taxes going forward. You pay the taxes on the money you contribute upfront, giving you less to pay when it is time to withdraw those funds.  

These are even different from tax-advantaged accounts which have their own unique advantages for those who hold them. Tax-advantaged accounts like 529 savings plans allow you to deduct the taxes from your income without having to pay future taxes (provided that you use the funds for the intended purpose). 

Types of Tax-Deferred Accounts

Chances are that you have already heard of some of the most common tax-deferred accounts as these tend to be great retirement savings vehicles. Retirement savings accounts are among the top tax-deferred accounts available, but they are not the only option. 

Here are a few of the most popular types of tax-deferred accounts:

  • Individual Retirement Accounts (IRAs): IRAs are a great vehicle to save for retirement because it allows you to contribute pre-tax dollars that can grow for years to come. You may earn more on these contributions because you have contributed more to the account, but you will pay taxes on the amount when you withdraw it in retirement. 
  • 401(k) and 403(b) Accounts: A 401(k) is an employer-sponsored retirement account which allows employees to contribute funds and employers may match a percentage of those funds. A 403(b) account is less well-known but has a similar structure. It is designed for those employed by public schools or nonprofits. 
  • Annuities: Annuities present you with a source of guaranteed income once you officially retire. You may receive payments for a set period of time or the remainder of your life, funded by tax-deferred contributions that grow tax-free until you start taking distributions. 
  • Health Savings Accounts (HSAs): HSAs are a unique savings account that allows you to fund them with pre-tax dollars to cover qualified medical expenses. Funds are not taxed unless you use this money for non-medical expenses. 

Common Pitfalls and How to Avoid Them

While there are many advantages to tax-deferred accounts, there are also some common pitfalls that you will want to avoid whenever possible. Consider some of these downsides to tax-deferred accounts before you make a final decision: 

Early Withdrawal Penalties

Because most of the tax-deferred accounts are designed for your use in retirement, there are some withdrawal penalties for taking money out prior to a certain age (usually 59 ½). If you do need to access these funds early, you are likely to be hit with a minimum 10 percent withdrawal penalty as well as income taxes. 

To keep from being hit with early withdrawal penalties, make sure you have a robust savings account or other form of liquid savings for emergencies prior to contributing the maximum amount to your tax-deferred accounts. 

Required Minimum Distributions (RMDs)

Some types of tax-deferred accounts like IRAs and 401(k) plans require you to take distributions once you hit a certain age, such as 72 or 73. If you find that you are faced with having to take distributions, seriously consider doing so as you will be hit with a 50 percent excise tax on the portion that you did not withdraw. Unlike taxable accounts which may have long-term capital gain tax treatment (and hence a lower effective tax), distributions from tax-deferred accounts will always be treated as ordinary income.


As mentioned in the previous point, you will be required to take distributions once you reach a certain age. Those distributions are based on life expectancy and the amount of money in your retirement savings account. If you overfund these accounts, you may have to pay taxes on the amount withdrawn, even if you did not truly need it for your living expenses. 

Keep in mind that the amount you must withdraw from your retirement savings account via the RMDs can push you into a higher income tax bracket which minimizes how much you effectively saved. It can also affect your Medicare premiums.

Not Understanding the Nuances Between Traditional and Roth Accounts

It is important that you understand the subtle differences between traditional and Roth savings accounts. Traditional accounts allow you to contribute pre-tax dollars and grow that money tax-deferred until you need it in retirement. Roth accounts allow you to contribute after-tax dollars for tax-free distributions in retirement. 

You may want to work with a financial advisor to determine which type of account is the right move for your retirement. You can also use our Taxable vs. Tax-Deferred Savings Calculator to get a general sense of the potential future value of your contributions.

Strategies to Make the Most of Tax-Deferred Accounts

If you want to make the most of your tax-deferred accounts, here are a few strategies you might want to employ to get the most out of your money. 

Asset Allocation, Regular Monitoring, and Rebalancing 

You should make sure that you have cost-efficient investments in your portfolio that are optimized for the long-term. Asset allocation refers to holding a collection of securities that will help protect your fund from disruptions in the market. This means that you may hold stocks, mutual funds, bonds, and more. 

Monitor your holdings regularly to see how they do and rebalance them as needed. This is where it can be helpful to work with an experienced financial planner. 

Know When to Choose Between Traditional and Roth Options

Work with a financial planner to determine whether traditional or Roth accounts are the better fit for you. Traditional accounts are great if you are in a higher tax bracket right now and will be in a lower bracket in retirement. The opposite is true for Roth accounts, so it will require some calculating to see how you can come out ahead. 

Consolidating Accounts and Rolling Over

One of the best things you can do to maximize your tax-deferred accounts is to consolidate them so that everything is all in one place. This minimizes your maintenance, often reduces fees, and makes it easier to track when and where your RMDs come from. Try to keep everything under a single umbrella for simplicity. Of course, this approach may depend on your current financial circumstances. Many people try advisor allocation to discover that really their advisors are overlapping positions.

Having a Withdrawal Strategy

Of course, you might have multiple tax-deferred accounts that require your attention. Have a robust and detailed withdrawal strategy that tells you which account to pull from first and when those distributions should be made.

It is not necessary that RMDs come from all sources respectively. The IRS does not care where you take your RMDs, as long as you take them. This may depend on which ones have early withdrawal penalties, your current tax bracket, the current state of the market, and so on. Remember, RMDs are taxed as ordinary income.

Get Professional Advice from Magellan Planning Group

Tax-deferred accounts are a great option for long-term savings, especially as you look toward the horizon for tax efficiency in retirement. Magellan offers financial and tax planning that can help you to streamline your savings accounts and make the most of your taxes. 

We are a one-stop-shop to help you get the most out of your savings, so contact Magellan today to learn more about how we can guide your most pressing financial decisions! 

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

Rebalancing may be a taxable event. Before you take any specific action be sure to consult with your tax professional.

Converting from a traditional IRA to a Roth IRA is a taxable event.

If you are purchasing an annuity to fund any tax-qualified retirement plan (IRA), you should be aware that this tax-deferral feature is available with any investment vehicle and is not unique to an annuity. Carefully consider the features and benefits of the annuity before making the decision to purchase.

To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.

Before deciding whether to retain assets in a 401(k) or roll over to an IRA, an investor should consider various factors including, but not limited to, investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Please view the Investor Alerts section of the FINRA website for additional information.

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.