To encourage people to start saving for their retirement, the government offers a number of tax incentives, including tax-deferred savings accounts. A tax-deferred savings account allows you to contribute a certain amount of money pre-tax into a retirement account, which means the amount is subtracted from your taxable income. The contributions are taxed later upon withdrawal.
Types of Tax-Deferred Savings Accounts
Traditional IRAs, 401(k) retirement accounts and SEP IRAs are examples of tax-deferred savings accounts.
Deducting the Contributions
With an employer-sponsored 401(k) retirement account, the contributions are taken out of your paycheck before being taxed. With a traditional or SEP IRA, you may claim the deduction at the end of the year on a Form 1040.
Contribution Limits
Contributions to a tax-deferred account are capped on an annual basis. For traditional IRAs, that limit is $5,000 per year if single, $10,000 if married and $6,000 if more than 50 years old.
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Withdrawing
Your money is taxed once you begin making withdrawals. Typically, you cannot withdraw money until the age of 59 ½, or you will incur penalties.
Considerations
If you have an employer-sponsored retirement plan, as well as a traditional IRA, your IRA contributions may not qualify for a tax deduction. Review IRS Publication 590 for details.