401k Deferral

A 401K deferral refers to the fact that the money you invest in your retirement plan is taken out of your income before taxes are taken out, which means you are putting off paying taxes on that money until you withdraw in retirement.

This doesn't mean you'll never have to pay taxes on this income, it just means that you're putting it off. You will be charged taxes in retirement when you withdraw the money. If this is new to you, you're probably wondering why you would want to do this. The truth is that you might not, so you'll want to look at the advantages and the alternatives and see what works best for you.

The 401k deferral puts off paying taxes on the money you invest until you retire. The money you invest comes out of your income before taxes, which means that it lowers the amount of income you actually have this year. If you are hovering over a tax bracket, then investing this money may lower your tax bracket, meaning you pay a lower tax percentage this year. On top of this, if you have a lower income level in retirement than you currently have then you will be paying a lower percentage in retirement as well. This means you'll save money.

The other benefit to this is that the money you would be paying in taxes now is instead in your account, being invested, and growing! That means that this money you would be paying in taxes will make you money over the next several years until you retire, which means more money for you in retirement than you would have otherwise. This will greatly help you grow your nest egg.

Of course, some of these advantages may not apply to your situation. For instance, if your income level is lower now than it will be in retirement than you will be paying a higher tax percentage on this money. We can make general guesses about your future situations, but for a lot of people it's hard to be sure.

You always have the option to take advantage of this option, and another, to spread out your tax obligations. Roth IRAs use money after taxes, which means they don't have the 401k deferral for your taxes. Before you make any of these decisions, however, it's best to consult a financial professional and become very educated about your options.

By: Jenn Quilter

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