The definition of tax-deferred growth is this: An investment in which some or all taxes are paid at a future date, rather than in the year the investment produces income.
When comparing tax-deferred accounts with annual taxable accounts, several factors need to be considered:
· How soon will the funds be needed?
· Are these funds to be used for retirement?
· What is your current tax rate, and will it increase or decrease in the future?
· What is the goal or use of the funds?
The time horizon for deferred account funds is an integral part of the decision process. If the funds are to be used in short-term time frames, tax deferral probably doesn’t make sense. If the funds are longer-term funds, then tax deferral may be a solid choice. If you take into fact your current tax liability, then the actual net gain can be established. Also, tax deferral allows for the growth of funds that would typically need to be set aside for taxes.
The original deposit will earn interest, and the tax that would be paid on the again could also be deferred and become interested earning assets along with the original principal. If you add the overall earned interest, then the combination of growth from these three areas will provide even greater funds in the future.
Think of it with this concept:
· Interest on the original deposit
· Interest earned on the interest from the original deposit
· Interest earned on the tax liability that would be deferred.
To best calculate the net annual saving on tax deferral, use this simple example.
$1,000 earning 6% interest.
The tax liability of 25%
Net annual yield after taxation would be 4.5%
If the funds could be tax-deferred, then the number of net dollars available would be greater just based on common sense. Every year the funds are tax-deferred the interest paid on the future accessed gain would be less because of the power of tax deferral.