Tax-deferred Investment Calculator


Use this calculator to compare the future value & annualized yield differences between a tax-deferred and a taxable investment. This calculator can help investors determine if it makes sense to invest in some instruments in tax sheltered accounts as well as making it easy to see the taxed equivalent yield on a tax-free investment like select municipal bonds.

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Optimizing Long-term Gains Through Tax-Deferred Assets

Guide published by Jose Abuyuan on August 27, 2020

Not today tax.

Building wealth over the course of your lifetime is a difficult undertaking. You work all day (or all night) to make sure there’s a little extra after all those bills. Especially in tough economic times, you’d need to work smarter and harder to save up for the future. Thus, you’d want to preserve as much of your hard-earned money as possible.

Life, however, is rarely that cooperative. Taxes are an inevitable part of life, even after your retirement. Meanwhile, inflation means that your money would lose its value, even when times are good. Mitigating these hazards can help preserve your savings and build wealth.

Among the most important tools in your tax management arsenal are tax-deferred investments. These provide a host of advantages that help you manage tax liabilities. Play your cards right, and you can enjoy a reduced tax burden now and tomorrow.

The Basics of Tax-Deferred Assets

Tax-deferred investments refer to a family of assets that delay taxation for a set period. The most well-known of these to the layperson are tax-deferred retirement accounts. These were first set up to encourage taxpayers to save for retirement. Other tax-deferred investments include 1031 exchanges, annuities, and whole life insurance.

Money locked in a tax-deferred asset continues to grow in value without taxes and will do so for years. They become counted as taxable income only when you liquidate them, which wouldn’t be for a long time. You usually avoid withdrawing from your retirement accounts until you actually retire. Meanwhile, you only ever need to pay capital gains taxes on an exchange if you sold your property in cash.

Tax-deferred investments have tax advantages in the short and long-term. While you work, you likely fall under a high tax bracket because of your earning ability. Upon retirement, however, you might fall under a lower tax bracket as your income shrinks. In fact, the tax rates in the distant future might be much lower than the rates today. Rather than paying today’s higher taxes, you instead pay tomorrow’s much lower taxes.

The Procrastinator’s Tax Advantage

By now, you’ve probably heard why procrastination is bad a trillion times. Even putting off your retirement investments for another day is ill-advised. What you can put off, however, is paying specific taxes.

Through tax deferral, you set aside a larger amount of money today. These funds earn a greater amount of compound interest over several years tax-free. The interest you earned is added to your principal, which helps you earn even more interest over time. Combine that with the much smaller tax burdens later in life, and you’ve saved up more and pay a lot less.

We’ll use a modest amount for our example. Let’s say you maxed out your contributions for one year for both your retirement accounts. Your total savings amount to $25,500. Your assets have a rate of return at around 7 percent per year. We’ll also assume that your deferred investments are taxed around 3.8 percent and your income is taxed around 22 percent.

Here’s what you can expect to earn in about 20 years:

Principal: $25,500
Rate/APR: 7%
Marginal Tax Rate: 22%
Taxable Percent of Deferred Savings: 3.8%

Future Value$73,840.65$97,603.18
Annualized Yield5.46%6.94%

You would’ve earned $23,762.53 more than you would have if you invested only your post-tax income. And that’s just a single year’s worth of maxed out investments. Imagine how much more you can make if you kept depositing that amount every year?

Tax-Deferred Retirement Options

For most people, the biggest tax deferred investments they make are retirement funds. They have two main tax-deferred retirement options:

  • Traditional 401(k) plans
  • Traditional individual retirement account (IRA)

Besides letting their contributions grow tax-deferred, these two accounts have many similarities. Both have upper limits to their contributions. These are extended upon reaching the age of 50 above.

The IRS also considers elective deferred contributions as tax deductibles. Often, you can receive your contributions as a tax return. If you had outstanding balances, however, the IRS deducts the amount from the taxes you owe. This is a win-win situation for many employees; you receive tax deductions today and a greater return of investment tomorrow.

Both types of tax-deferred plans also have a tax-free equivalent. Roth IRAs and 401(k)s are less common than their traditional counterparts and use post-tax dollars for investing. They have a much smaller contribution limit, however, and aren’t as efficient in building wealth.

401(k) Plans

The 401(k) plan is an employer-sponsored investment tool first introduced in 1978. These served as an alternative to long-term pension plans for employees. Many employers offer this as an option for all their employees. A few companies automatically provide employees with one upon hiring. 401(k) plans consist mainly of mutual funds that offer a diversified spread of bonds, stocks, and money market investments.

Generous employers often offer to match their employee’s contributions. Today, most employers offer to match contributions of up to 3 percent of their employee’s salary. If you have a $50,000 annual salary, the amount your employer would match would be $1,500. You can, of course, exceed your contributions.

Often, you must work for your employer within a set time before they give you full access to their contributions. This process is known as vesting and can last up to four years. Vesting is done either all at once or through increments of 22 to 33 percent. If you leave the company after a year, you can only take 33 percent of your matched contributions with you. After that, you are free to take your employer’s matched contributions if you ever leave the company.

Employees can make voluntary contributions to their 401(k) plans up to an annual limit. This limit comprises the total dollar amount of you and your employer’s contributions. As of 2020, contributions are capped at $19,500. Adults aged 50 years and above can also make catch-up contributions amounting to $6,500. This can help bolster their retirement savings even as they enter their golden years.

Pigly's Tip!

If you ever get retrenched or otherwise leave your job, do not empty your 401(k) plan. Keep the money there and roll your earnings over to another tax-deferred retirement fund. This could either be your IRA or a 401(k) set up by your new employer. You should also roll out your 401(k) funds if your company goes under.

Traditional IRAs

Unlike 401(k) accounts, traditional IRAs are set up individually. Traditional IRAs use pre-tax income to invest. These are distinguished from Roth IRAs, which invest post-tax income.

Much like 401(k)s, traditional IRAs provide investors with some degree of control over their assets. While you have the option of a custodian to manage the accounts on your behalf, you can also manage it yourself. This gives you greater control over the mix of assets you invest in.

Traditional IRAs have a much lower contribution limit compared to 401(k)s at $6,000 as of 2019. Older adults aged 50 years and above can contribute an extra $1,000. As long as you have enough income to contribute to a traditional IRA, you can qualify for an IRA tax deduction. This cannot come from investment income, though it can come from rental income. Your maximum tax exemption will be the same as your contribution cap.

The amount you can deduct, meanwhile, will depend on your modified adjusted gross income (MAGI). As of 2020, you cannot apply for an IRA tax deduction if you fulfill the following conditions:

  • If you are single or are filing as the head of a household, and your annual MAGI exceeds $75,000. You also take on a much smaller deductible if your MAGI is between $65,000 and $75,000.
  • If you are married and filing jointly and your annual MAGI is over $124,000. Your deductibles are smaller if your MAGI is between $104,000 and $124,000. These also apply if you are a qualified widow or widower.

Did You Know?

If you make contributions to the IRA of a nonworking spouse, you can file for two tax exemptions instead of one. That’s a maximum of $14,000 if you’re both over 50 as of 2020!

1031 Exchanges

Trading an apartment for a commercial building.
Defer taxes through reinvestment.

Retirees aren’t the only ones who must plan around taxes. Real estate investors can expect hefty capital gains taxes when they sell property. This can cut into the profits you expect to gain and derail your plans for reinvestment. To avoid this, many investors turn to 1031 exchanges. These are named after the section of the tax code that allows them.

A 1031 exchange lets investors defer their capital gains tax by purchasing a new property shortly after selling. On paper, they must do this within 180 days. The new property bought must be of equal value or greater to the property you sold to qualify as reinvestment.

You can rarely find properties that cost exactly the same. Thus, you have two options. The first is to buy a property of slightly lower value. Much of your taxes are deferred for everything but the money you left behind, which is called the boot. To avoid paying taxes on any boot amount, you can instead buy a more expensive property. In any case, you will not need to pay taxes again until you’ve sold your new property.

“Like Kind” Exchanges

1031 exchanges can apply only to “like kind” investment properties. Rental properties, both residential and commercial, fall under this umbrella. Your personal residence does not. For tax purposes, the IRS counts all kinds of rental and commercial real estate. Quality or grade is a non-issue. You can exchange a rental duplex for a piece of raw land if the price is right.

In the past, the phrase “like kind” was unclear. This created several situations where 1031 exchanges could be done with machinery and art. The practice continued for a time until the IRS revised its rules in 2018. Today, “like kind” properties refer to real estate within the United States in exclusion.

Other Tax-Deferred Investments

Investors have a long list of other tax-deferred assets and accounts to put their money into. They are not as popular as the other options due to their unique risks and challenges. For some people, however, these can be a terrific addition to their portfolio.


Annuities are another way for prospective retirees to provide for their needs. Once matured, these investments will pay their owners either a lump sum or a monthly stipend. This can last for either a set period or their entire lifetimes. They are also becoming a popular investment option.

One form, the qualified variable annuity, is tax-deferred. You can choose the mix of assets that go into the annuity, which is paid for through a lump sum. This is locked for several years (commonly 15) and compound tax-free. The resulting profit can be redeemed either as a lump sum or in increments. These annuities may also have death benefits. Your loved ones can inherit the account in case you die before cashing it out.

The main drawback of qualified annuities is their high maintenance charges, which can be as high as 1.5 percent of your earnings. These can easily cancel out the benefits of deferring taxation on your assets. Moreover, they are also hard to liquidate. Selling an annuity leads to smaller yields than redeeming it on schedule.

Whole Life Insurance

Whole life insurance combines the functions of life insurance and an investment portfolio. This is often sold as an alternative to the much cheaper term life insurance. The appeal of this product for policyholders is simple enough. Term life insurance sometimes feels like you’re throwing money away. Once a term life insurance policy expires, you don’t receive anything.

Did You Know?

Tax-deferred whole life insurance policies are governed under Section 7702 of the U.S. Internal Revenue Code. They are thus sometimes marketed by insurers as a 7702 plan.

Whole life insurance guarantees similar coverage and investments to go along with it. As you grow older, you can also borrow against this policy. Should you die, your beneficiaries would receive a death benefit tax-free. You may even redeem this for a lump sum later in life.

However, whole life insurance has its drawbacks. It is pricier than term life insurance and has extra costs tied to it, including commissions. Its more modest returns, meanwhile, are outperformed by other investments over time. Moreover, contributions to whole life insurance aren’t tax deductible.

Penalties and Other Caveats

Tired man doing calculations.
Be wary of withdrawal penalties.

Tax-deferment delays your taxes until you withdraw. When this will be depends on the asset. It is prudent to leave your money where it is until that time comes. This way, you can take advantage of compounding. Withdraw too soon, and you could feel the pinch.

For tax-deferred retirement accounts, you can expect a hefty penalty of up to 10 percent of your earnings when you take them out prematurely. This could be at any time you are below the age of 59 and a half years outside other triggering conditions like disability or termination. The penalty keeps you from using that money for anything other than retirement.

You also have the option of leaving these funds untouched after the penalty period lapses. This can buy you some more time for their interest to compound. However, you cannot keep doing this forever. By age 72, you are required to make minimum distributions from your accounts. This means you must begin making minimum withdrawals to your 401(k) and IRA accounts once you reach that age.


Withdraw from your tax-deferred accounts early to pay off debts only if you have no other choice. On the surface, you have everything to gain. Debt payments outperform investments in the short short term. But you face stiff tax penalties and lose out on larger future gains if you do so.

Be careful when swapping different types of real property in a 1031 exchange. Buildings depreciate in value, which can be written off as tax deductibles. If you traded land with buildings for raw land, you may end up generating a profit. This is taxed as ordinary income in what is known as depreciation recapture. You can prevent this by trading properties that are more similar, such as one commercial building for another.

In addition, 1031 exchanges are also complex affairs that have a tight deadline. You should only pursue this course of action if you’re equipped to do everything fast and by the book.

An Integrated Tax Strategy

Group of people making plans about budget.
There should be room for all kinds of investments in your game plan.

Tax management is a crucial aspect of smart financial planning. Ensuring that you pay only your fair share is an ongoing process. When lowering tax burdens, it pays to think two steps ahead.

Tax-exempt retirement investments can be a crucial part of your tax efficiency arsenal. The two most common types are Roth IRAs and Roth 401(k) plans, which are paid for with post-tax dollars. Because you don’t need to pay taxes once it’s time to withdraw, they seem quite attractive on the surface.

Roth IRAs and 401(k) plans, however, don’t perform as well as their traditional counterparts. They have lower contribution limits, which leads to a smaller starting principal. Because they’re paid with post-tax dollars, they have no taxation benefits today.

Whether you should focus on one or the other depends on where you’ll think you’ll be in the future. Most people put their savings in a tax-deferred account in anticipation of lower taxes in the future. Retiring from their jobs causes their income to plummet. If you expect to be at a higher income bracket in the future, focusing on tax-free income might be a good option.

The Bottom Line

Investing is a long-term game plan. It pays to make the right moves in the present, even if you don’t expect the payoff until several years on. Your retirement cash flow, for instance, depends on making wise decisions with your savings today.

Remember, the biggest ally you have is time. Regardless of where you put your money, it will only work for you if you save it now. So the saying goes, the best time to invest was yesterday. As the second-best time, today is the right moment for retirement planning. The sooner you start, the more time you have to compound and adjust your strategy as necessary.

A bigger principal on the onset can help you leverage the power of compounding. One of the best uses for your extra money is to bolster your retirement contributions. Max out your contributions to tax-deferred assets before investing elsewhere.

Pigly's Tip!

Don’t leave free money on the table! If your employer will match your contributions to a limit, max that out first. This way, you will rely less on your own money to reach your contribution limits.

Tax efficiency is important, but it shouldn’t be the linchpin of your entire investment strategy. You could miss out on tremendous gains if you focus only on minimal tax losses. Examine each investment carefully and look at your potential gains. Your ultimate goal should be for your investments to outperform your tax burdens.

Of course, before you think of investing, you’ll need to free up your cash flow. One of the best ways to do that is by eliminating your longstanding debts. Check out our guide on our accelerated debt repayment calculator.

About The Author

Jose Abuyuan is a web content writer, fictionist, and digital artist hailing from Las Piñas City. He is a graduate of Communication and Media Studies at San Beda College Alabang, who took his internship in the weekly news magazine the Philippines Graphic. He has authored works professionally for over a decade.

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