Tax-Deferred Growth

In a normal taxable account, investors may pay tax on investment income and realized gains each year, reducing the amount left to grow. In a tax-deferred account, all earnings stay invested, so the full amount continues to compound until withdrawal.

For example, consider 10,000 invested for 20 years at 7% a year. If 25% of each year's return is lost to tax, the effective growth rate falls to 5.25% and the investment grows to about 27,800. If growth is tax-deferred, it grows to about 38,700. Even if 25% tax is then paid on the total gain at withdrawal, the investor keeps about 31,500, noticeably more.

Many retirement accounts and some insurance products offer tax-deferred growth. Some also provide tax relief on contributions.

The benefit of deferral is greatest over long periods and for investments with high taxable income each year. It can be even more valuable if the investor expects to be in a lower tax bracket when withdrawing money, for example in retirement.

Tax-deferred accounts usually limit access to the money before a certain age or for certain purposes, and rules differ between countries.