Deferred Account

A deferred account is a financial account that postpones tax obligations until a later date, allowing the account holder to potentially reduce their current tax burden.

Definition

A Deferred Account is a financial account that allows the postponement of taxes on income or investments until a future point in time. The primary purpose of such accounts is to enable tax-advantaged growth or savings, offering individuals or businesses a means to manage their tax liabilities more effectively. Contributions made to deferred accounts often exist under specific regulations and benefit from favorable tax treatment.

Examples

  1. Individual Retirement Account (IRA): An IRA is a retirement savings plan that offers tax advantages. Contributions to a traditional IRA may be tax-deductible, and investment earnings can potentially grow tax-deferred until withdrawals are made.

  2. Keogh Plan: Named after U.S. Representative Eugene Keogh, this is a tax-deferred pension plan for self-employed individuals and unincorporated businesses, providing opportunities to save for retirement with advantageous tax treatment.

  3. Profit-Sharing Plan: This type of plan allows a company to share profits with its employees. Contributions made by the employer are tax-deferred until the employee withdraws them, typically during retirement.

  4. Salary Reduction Plan (SEP-IRA): Simplified Employee Pension (SEP-IRA) plans are tailored for self-employed individuals or small businesses. Contributions made to these plans are tax-deferred, helping plan participants save for retirement while enjoying tax benefits.

Frequently Asked Questions

Q: What is the primary benefit of a deferred account? A: The primary benefit is the tax deferral, which allows the investments to grow without being reduced by taxes until the time of withdrawal, potentially resulting in higher returns.

Q: When are taxes paid on deferred accounts? A: Taxes on deferred accounts are paid upon withdrawal, which usually happens during retirement.

Q: Are there penalties for early withdrawal from a deferred account? A: Yes, early withdrawals (typically before age 59½) from many deferred accounts like IRAs may incur penalties along with the taxes due on the withdrawal.

Q: How do deferred accounts benefit retirement planning? A: Deferred accounts benefit retirement planning by allowing tax-deferred growth, thereby accumulating higher savings over time due to the postponement of tax payments.

  • Individual Retirement Account (IRA): An account that provides tax advantages for retirement savings.
  • Keogh Plan: A tax-deferred pension plan for self-employed individuals and unincorporated businesses.
  • Profit-Sharing Plan: A plan that allows companies to share profits with employees in a tax-deferred manner.
  • Salary Reduction Plan (SEP-IRA): A retirement plan that allows small businesses or self-employed individuals to make tax-deferred contributions toward retirement savings.

Online Resources

Suggested Books for Further Studies

  • Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches by Lawrence F. Laren and Joan M. Laren
  • IRA Wealth: Revolutionary IRA Strategies for Real Estate Investment by Patrick W. Rice
  • The New Pension Strategy for the Self-Employed by Martin S. Shenkman

Fundamentals of Deferred Account: Finance Basics Quiz

### What is the primary feature of a deferred account? - [x] It postpones taxes until a later date. - [ ] It eliminates taxes entirely. - [ ] It decreases the amount of taxes. - [ ] It provides a constant tax rate. > **Explanation:** Deferred accounts primarily allow for the postponement of taxes on contributions and growth until a future date, usually retirement. ### In a Keogh Plan, who can set up this type of deferred account? - [ ] Any individual - [x] Self-employed individuals or unincorporated businesses - [ ] Only large corporations - [ ] Employees in a fleet management company > **Explanation:** A Keogh Plan is specifically designed for self-employed individuals and unincorporated businesses to defer taxes and contribute toward retirement savings. ### When must taxes typically be paid on a deferred account? - [ ] At account opening - [ ] Annually, regardless of withdrawals - [x] Upon withdrawal - [ ] Never > **Explanation:** Taxes are typically paid when the funds are withdrawn from the deferred account, often during retirement. ### What does SEP-IRA stand for? - [x] Simplified Employee Pension Individual Retirement Account - [ ] Standard Employer Provided Individual Retirement Account - [ ] Supplementary Employee Pension Independent Reserve Account - [ ] State Employee Pension Investment Retirement Account > **Explanation:** SEP-IRA stands for Simplified Employee Pension Individual Retirement Account, designed for small businesses and self-employed individuals. ### What is a potential penalty for early withdrawal from an IRA? - [ ] Enhanced interest rates - [x] Penalties and taxes on the amount withdrawn - [ ] Increase in tax deferment period - [ ] No penalties apply > **Explanation:** Early withdrawals from an IRA before the age of 59½ can result in penalties and taxes on the withdrawn amount. ### Is a profit-sharing plan considered a deferred account? - [x] Yes, it is. - [ ] No, it isn't. - [ ] Only partially - [ ] Only in certain industries > **Explanation:** Yes, a profit-sharing plan is a type of deferred account as it allows for contributions to be made that are tax-deferred until withdrawn. ### Which type of deferred account is particularly beneficial for small businesses? - [ ] Traditional IRA - [x] SEP-IRA - [ ] Roth IRA - [ ] 401(k) > **Explanation:** SEP-IRA is particularly beneficial for small businesses and self-employed individuals because of its simplicity in administration and tax advantages. ### By deferring taxes, what advantage can individuals achieve in their retirement planning? - [ ] Eliminating all taxes forever - [x] Allowing the investments to grow without being reduced by taxes in the short term - [ ] Lowering market risks - [ ] Simplifying tax filings > **Explanation:** By deferring taxes, investments can potentially grow without being reduced by taxes until the date of withdrawal, often leading to higher returns. ### Can an IRA be tax-deductible at the time of contribution? - [x] Yes, it can. - [ ] No, it cannot. - [ ] Only certain types of IRAs - [ ] Only if an employer offers the IRA > **Explanation:** Contributions to a traditional IRA can often be tax-deductible, providing immediate tax benefits. ### What is the tax status of earnings within a deferred account? - [ ] Taxed annually - [x] Tax-deferred until withdrawal - [ ] Tax-free forever - [ ] Partially taxed each year > **Explanation:** Earnings within a deferred account are typically tax-deferred, meaning they are not taxed until withdrawn.

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Wednesday, August 7, 2024

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