Tax-Deferred or Tax-Exempt? Potential Benefits to Having Both

Over the years, you may have heard it’s good to have different “kinds” of money as you head into retirement. A financial advisor may recommend a combination of tax-deferred and tax-exempt financial products, diversifying your money to help take advantage of the tax benefits both types of products provide.


What many people don’t understand, however, is why it’s important to take advantage of the different types of financial products available. What are the potential benefits of utilizing both tax-deferred and tax-exempt products? First, let’s take a look at the difference between the two.

A tax-deferred financial product means simply that: You owe taxes on the money, but those taxes have been deferred or pushed back. You haven’t paid any taxes on the contributions or the growth that’s occurred over the life of the product. When you take money out of it, those distributions are 100 percent taxable at ordinary income rates.1 Withdrawals taken prior to age 59 1/2 may also be subject to an additional 10 percent federal tax.

What types of financial products are tax-deferred? A 401(k), 403(b) or traditional IRA are all examples of tax-deferred investment products. Growth in some types of annuities or life insurance policies may also be tax-deferred.2

Tax-exempt means no taxes are owed on qualified distributions made from the financial product. A Roth IRA or Roth 401(k) is a good example of a tax-exempt account. Contributions to a Roth are made with money that’s already been taxed.3

So why can it be beneficial to have a mix of tax-deferred and tax-exempt financial products in your financial strategy? Mostly, it gives you flexibility in how you take distributions during your retirement. For example, you might use distributions from tax-deferred products to pay for your fixed expenses every month. If you have expenses that are outside of your “normal” spending — such as a vacation or a large purchase — you could use money from a tax-exempt product and not incur a taxable event.

While it could be tempting to go heavy in tax-exempt financial products when you’re establishing a financial strategy, using a tax-deferred product may put more money in your pocket in the long run. Many people are in a lower tax bracket during their retirement years. If that is the case, you may pay less taxes on distributions during retirement than if you were paying taxes on your contributions up front while still working.4

What’s the right mix of tax-deferred and tax-exempt financial products for you? Every situation is unique. If you’re not sure what types of financial products you should be using, give us a call. We can look at your existing financial strategy and make recommendations based on your specific circumstances. We can also help you determine if life insurance and annuities could play a part in your tax-efficient strategy. Our mission is to help you plan for the best retirement possible.


Content prepared by Amy Ragland

1 The Balance. “What is a Tax-Deferred Investment Account?” https://www.thebalance.com/tax-deferred-savings-account-and-investments-2388988. Accessed May 31, 2017.

2 Prudential. “Tax Strategies: Tax-Deferred Annuities.” http://www.prudential.com/view/page/public/12609?param=12624. Accessed June 1, 2017.

3 Teresa Mears. U.S. News & World Report. Dec. 19, 2014. “7 Retirement Savings Accounts You Should Consider.” http://money.usnews.com/money/personal-finance/articles/2014/12/19/7-retirement-savings-accounts-you-should-consider. Accessed May 31, 2017.

4 Arthur Pinkasovitch. Investopedia. “Retirement Savings: Tax-Deferred or Tax-Exempt?” Updated April 5, 2017. http://www.investopedia.com/articles/taxes/11/tax-deferred-tax-exempt.asp. Accessed May 31, 2017.

We are not permitted to offer, and no statement contained herein shall constitute, tax or legal advice. Individuals are encouraged to consult with a qualified professional before making any decisions about their personal situation.

We are an independent firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives. This material is intended to provide general information to help you understand basic financial planning strategies and should not be construed as financial advice. All investments are subject to risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. 

The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions. If you are unable to access any of the news articles and sources through the links provided in this text, please contact us to request a copy of the desired reference.