Tax-deferred investments allow you to place money in a secure spot without facing the expected financial consequences. Your tax bill isn’t wiped away, as the government will expect its money at some point. However, that date could be far enough in the future that you can plan for it.
Some tax-deferred investments are well known. However, others are subtle and easy to overlook. We’ll outline a few of those options and help you understand how to make a smart decision for your portfolio.
What Is Tax Deferment?
Many people assume that financial tools allow them to skip out on their tax obligations altogether. This is a mistake.
Tax-deferred investments allow you to push the due date of your bill into the future. However, you will likely be required to pay what you owe at a later date. Exceptions exist, which is why making a smart choice matters so much. However, it’s always wise to expect a bill for your unpaid taxes and plan accordingly.
7 Tax-Deferred Investments to Consider
Several tax-deferred investments exist, and they’re all slightly different. These are a few of the options we like best, along with some tips to help you make them work for you.
1. 401(k) Retirement Accounts
According to surveys from the U.S. Census Bureau, a 401(k) is the most common type of retirement account Americans hold. More than 34% of Americans have them.
A 401(k) is typically provided by an employer and allows staff to contribute a portion of their wages to these individual accounts. Sometimes, employers can contribute to them too in what are often called “employer matching programs.” Distributions are taxed when they’re withdrawn at retirement age, making these tax-deferred plans.
While 401(k)s are often associated with full-time work done for someone else, self-employment versions exist. If you’re an investor with no full-time job, you could open an account and set aside pre-tax dollars for your retirement.
2. 529 College Savings Plans
The Securities and Exchange Commission explains that 529 plans are designed to encourage people to save for future education bills. They’re typically sponsored by states, state agencies, or educational institutions.
Most 529 plans allow people to deduct their contributions from their federal income tax liabilities. When the earnings are withdrawn by the beneficiary, they’re typically not subject to federal income tax.
However, some states do tax their 529 plans when the withdrawals happen. In a state like this, a 529 college saving plan could be considered simply tax-deferred (and not tax-free). Confirm the details with your state before proceeding.
3. 1031 Exchange
In a traditional real estate transaction, profits are subject to taxes. Section 1031 of the Internal Revenue Code allows people to postpone those taxes. Investors create a complex transaction involving two properties. One is sold, and the other is purchased. The tax liabilities roll into the new property and don’t come due until it’s sold.
A traditional 1031 exchange is used for two already built assets, such as an office building or an apartment complex. However, more flexible options are available. For example, you could try a 1031 exchange and use the proceeds of the sale to fund new construction. These projects, often called build-to-suit exchanges, could reap big benefits.
4. Health Savings Accounts
A health savings account (HSA) allows investors to set aside pre-tax dollars for qualified medical expenses. While you can’t use the money to help you cover health insurance premiums, you can use the funds to cover things like copayments, deductibles, and other health-related expenses.
When you use HSA dollars for qualified expenses, they’re not subject to tax. However, if you grab the funds and use them for something else (like rent), the income can be taxable.
5. Indexed Universal Life Insurance
Most types of life insurance can’t be considered smart tax-deferment strategies, but there is one exception. Indexed universal life insurance (IUL) is a form of life insurance with a cash value. It can earn interest associated with a stock market index you pick. Typically, these accounts come with a guarantee, so you don’t lose more than you expected.
The value of your account can grow over time, but you won’t pay taxes on them unless you withdraw them. That makes these accounts tax-deferred options.
6. Municipal Bonds
The U.S. Securities and Exchange Commission explains that municipal bonds are issued by states, cities, and other governmental entities. Investors essentially loan these organizations money, and they get regular interest payments in return. Most of these bonds need time to mature (or deliver benefits).
Typically, the interest on these bonds isn’t subject to federal income tax. In some cases, they may be exempt from state taxes. However, these accounts can be tax-deferred (and not exempt). For example, if you live in a state other than the one that issued the bond, you could be taxed on the income as it’s delivered.
7. Traditional IRA
A traditional IRA allows investors to make contributions that are fully or partially deductible from state or federal income taxes. You must wait to withdraw those funds until you reach retirement age. When you do pull the money out, the earnings are taxable.
A traditional IRA can be a good option for investors who are self-employed and don’t want to open an independent 401(k). They come with tighter restrictions, but they can be easier to open as well.
How to Choose the Right Option for You
We’ve listed several financial tools you can use to set aside money and delay your potential tax bill. How can you choose the right one?
In 2022, about 35% of Americans worked with a financial advisor. If you’re unsure about which option is right for you, this could be a good resource. An expert guiding you through the process helps to ensure you make the best choice for your long-term situation and that you complete all the necessary steps. If you skip a step or miss an important deadline, it could disqualify you from the desired tax benefits.
You can also experiment with your investment options and watch the returns. You may find that one works the best for you.
We Can Help With 1031 Exchanges
While some tax-deferred investment options are designed for ease, others just aren’t. For example, it may be easy enough to talk with your employer and open up a 401(k) account. Setting up a complicated real estate transaction could be very difficult.
At 1031 Pros, we specialize in helping investors set up and complete complex real estate transactions. We can help you understand if this is a smart option for you, and if you move forward, we can handle the specifics and ensure it works smoothly. Contact us to find out more and start the conversation.
References
Who Has Retirement Accounts? (August 2022). United States Census Bureau.
401(k) Plans. (January 2024). Internal Revenue Service.
Like-Kind Exchanges Under IRC Section 1031. (February 2008). Internal Revenue Service.
Updated Investor Bulletin: An Introduction to 529 Plans. (August 2023). U.S. Securities and Exchange Commission.
How 529 Plans Help Families Save for College; How the American Recovery and Reinvestment Act of 2009 Expanded 529 Plan Features. (September 2009). Internal Revenue Service.
Health Savings Account. Offices of Human Resources Management.
What Are Municipal Bonds? (June 2024). U.S. Securities and Exchange Commission.
Tax-Exempt Bonds. Internal Revenue Service.
Roth IRAs. (August 2023). Internal Revenue Service.
Traditional IRAs. (December 2023). Internal Revenue Service.
Individual Retirement Arrangements (IRAs). Internal Revenue Service.
IRA Deduction Limits. Internal Revenue Service.
Share of Americans Who Work With a Financial Advisor in 2022. (March 2024). Statista.
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