You know that we love the idea of filling up the Tax-Free Bucket. So why would we ever want to put funds into the Pre-Tax Bucket at all!? The truth is, kicking the “tax-can” down the road can be beneficial to some clients in some circumstances. We rarely advise anyone to avoid deferring taxes altogether. Let’s look at some compelling numbers for deferral and then some high-level ways that you can defer taxes.

One of the most common ways to NOT pay taxes now and pay them later is through employer-sponsored plans like 401(k)s or 403(b)s. When you contribute to one of these plans (specifically, pre-tax), it effectively takes the amount of the contribution OFF your current income to be paid later. This is great if you are in one of the highest tax brackets and plan to retire into a lower bracket. 

For example, if your household income is currently $400,000, your highest dollars are being taxed at 32% (2024). If you plan to live on $250,000 in retirement, your highest income bracket will be 24%. You could use your employee deferral max in your 401k of $23,000 and lower your taxable household income to $377,000 for the current year. You would pay the income tax on those funds when you withdraw them in retirement at your lower bracket.

Full disclosure – this is oversimplified. There are a LOT of moving calculations that go into this example above, but we hope that it gives you an idea of why we LIKE tax deferral. You would also need to consider the fact that most employer-sponsored plans offer a match on contributions.

You are also able to use Traditional IRAs, SEP IRAs, Simple IRAs, and Defined Benefit Pension plans to accomplish the same income deferral as the 401(k)s, 403(b)s, 401(a)s and 457s. To go one step further, you can put after-tax dollars into some annuity products and avoid paying taxes on the income and capital gains until annuitization. The last way to defer taxes is by exchanging investments like insurance policies or investment real estate via 1035/1031 exchanges. These last 2 topics are beyond the scope of this email, but worth knowing about their existence. We discussed capital gains in THIS EMAIL, which is the only taxes that get deferred in exchanges (still pay income taxes along the way, if applicable).

Next up: Location Help – Where Are “Carryover Capital Losses” on Your Tax Return?

Disclosures

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.