If someone tells you that they will allow you to invest some money without paying taxes on it in advance, you would be a fool not to take advantage of the offer. That is the simple definition of a tax deferred savings plan. This is an account, registered with the government, which offers you the opportunity of putting off paying tax obligations.
Some such savings plans defer taxable income until withdrawal, and others defer until a particular date. Most commonly describing retirement savings plans such as 401(k)s or IRAs, they can also be educational savings plans or other accounts. Such accounts provide a shelter to income which would normally be taxed. The taxes are not avoided permanently – just until the funds are withdrawn.
The advantage for the investor is that the money which would have gone to taxes instead is used for further investment opportunities. You get to use the money that should have gone to the government to increase your holdings before you have to turn it over.
Since your tax rate is likely to be significantly lower once you retire you will pay less taxes on the investment overall. More money in the account over the years also means greater interest earnings. Just make sure you don’t withdraw these funds before you are allowed to do so. Not only will you pay taxes, but there is a 10% penalty. There are some unique circumstances in which the penalty is not charged, for example when purchasing your first home, or for medical expenses.
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