Legal Definitions - tax-deferred

The term tax-deferred describes income, gains, or investments where the payment of taxes is postponed until a future date or event. This means that you do not pay taxes on that money or its growth in the current year, but you will pay them later, typically when you withdraw the funds or when a specific condition is met.

• Example 1: College Savings Plan (529 Plan)
  A parent invests money into a 529 college savings plan for their child's future education. The funds within this account grow over many years.

  How it illustrates "tax-deferred": The investment gains within the 529 plan are not taxed annually. Instead, the taxes on these gains are deferred. As long as the money is eventually withdrawn and used for qualified educational expenses, the gains are never taxed. If withdrawn for non-qualified expenses, the deferred gains become taxable at that point.

• Example 2: Real Estate "Like-Kind" Exchange (1031 Exchange)
  An investor sells an income-generating rental property and, following specific IRS rules, uses the proceeds to purchase another "like-kind" investment property within a set timeframe.

  How it illustrates "tax-deferred": Normally, selling an investment property for a profit would trigger capital gains taxes. However, in a properly executed 1031 exchange, the capital gains tax on the sale of the first property is not paid immediately. It is deferred, allowing the investor to reinvest the full amount of the sale proceeds into the new property. The tax liability is postponed until the replacement property is eventually sold without another exchange, or if the owner takes cash out.

• Example 3: Non-Qualified Annuity Contract
  An individual purchases a non-qualified annuity from an insurance company, contributing after-tax money. The annuity then invests these funds, and the value of the annuity grows over time.

  How it illustrates "tax-deferred": The earnings and investment growth within the annuity accumulate without being subject to income tax each year. The taxes on these earnings are deferred until the individual begins to receive payments from the annuity or makes withdrawals. This allows the investment to potentially grow more rapidly because the gains are not reduced by annual taxation.