Tax deferral

Postponing a tax liability rather than removing it, so the money that would have gone in tax keeps compounding in the meantime.

Example

An unrealised gain is deferred until the asset is sold; the bill arrives then, at whatever rate applies in that year.

Important

Deferral is not avoidance. It buys the use of the money and some control over timing, and it carries a risk the taxed-annually path has already discharged: nobody knows the rate in the final year.

Related terms

• Tax drag — The reduction in compounding caused by paying tax earlier than necessary - the tax itself plus everything that tax would have earned had it stayed invested.
• Taxable event — The moment a tax system treats something as having happened - most commonly a sale, rather than an increase in value while you still hold the asset.
• Tax wrapper — An account or structure that changes how the assets inside it are taxed, without changing the assets themselves.

Lessons that explain it

• The account is a wrapper; what you hold inside it is a separate decision — A retirement account is a legal container with tax rules and access limits. It is not an investment itself, and the choice of wrapper and the choice of holdings are two different decisions. (9 min)
• Three sources: employer money, tax saved, and compounding left alone — Returns inside a retirement account come from the investments, plus two things outside the market: employer contributions and the tax that is not taken each year. (11 min)
• Pre-tax or post-tax is really a bet on your tax rate now versus later — The two main account structures give the same result if your tax rate is the same when you contribute and when you withdraw. The choice turns on whether you expect your rate to be higher or lower in retirement. (12 min)
• Early access is expensive, fees compound, and the rules can change — The main costs of retirement accounts are taxes and penalties on early withdrawal, fees inside the plan, and the risk that governments change contribution, withdrawal or tax rules. (11 min)
• Turnover, the taxable event, and the cost of selling — In most systems a gain is taxed when it is realised, not when it happens. That single rule means how often you trade changes your return even when every trade is correct. (11 min)
• The same investment can keep very different amounts depending on which account holds it — Asset location means putting heavily taxed investments inside tax-advantaged accounts where available, and lightly taxed ones in taxable accounts. The effect compounds over decades. (12 min)

All 578 terms in the Investing glossary