What Is a Tax-Deferred Savings Account?

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.

Traditional IRAs, 401(k) retirement accounts and SEP IRAs are examples of tax-deferred savings accounts.

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.

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.

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.

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.