Tax-Deferred Investment Calculator

Key terms

Current investment balance

Enter the beginning balance you want to invest.

Annual contributions

Enter the amount of money you expect to contribute each year. For example, if you are under age 50, you may want to make the maximum IRA contribution of $6,500 per year.

Number of years to invest

Enter the number of years for which you want to compare results. It may be the number of years until you plan to retire, or any other time period.

Before-tax return on fully taxable investment

The before-tax return on your fully taxable investment is the amount you receive before you pay state and federal income taxes. With taxable investments, you pay tax every year on realized gains and returns.

Return on tax-free investment

If an investment pays returns free of both state and federal income tax, you can compare the return on your tax-free investment to the after-tax return on other types of investments.

Before-tax return on tax-deferred investment

Depending on the type of tax-deferred investment, you pay tax at a later date. For example, you pay tax in the year you sell a stock at a gain or when you withdraw funds from a tax-deferred retirement account. The before-tax return is your total return before state and federal income tax.

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Marginal tax bracket

You pay different tax rates at different levels of your income. No matter how much money you make, you pay a low tax rate on the first level of your taxable income, and graduated rates on each level thereafter. When income reaches another tax bracket, you pay only the new, higher rate on the income that falls in that higher bracket. The highest rate you pay is called your marginal tax bracket.

What’s the difference between taxable, tax-deferred and tax-free investment growth?

Investments may be taxed when you receive a return, at some later date, or not at all. Here’s how it works:

Taxable investments

With taxable investments, you basically pay taxes every year. The simplest example of a taxable investment is a savings account or a money market account. You add money to the account, and you pay tax on the interest earned. You don’t get a tax deduction for contributing to the account as you would with a traditional IRA contribution. However, when you withdraw the money before or after retirement, you don’t have to worry about penalties or income tax on the withdrawals. You pay tax as you go, so the money is yours when you want to use it.

Other taxable investments, such as dividend-paying stocks, work basically the same way.

Tax-deferred investments

Tax-deferred investments let you put off paying tax until some later date, generally when you sell an asset or when you withdraw funds in retirement.

A traditional IRA, for example, allows you to defer paying taxes on both your contributions and any income in the account until you make withdrawals, generally in retirement. You still pay tax on the balance in your account, but you pay it later. Bear in mind that the calculator does not take into account that you may have more money available to invest if you contribute to a traditional IRA or other tax-advantaged retirement account, because you receive a tax deduction in the year you make the contributions.

Another type of tax-deferred investment is long-term capital investments. If you buy a growth stock, for example, you can hold it for years without paying tax on its gain in value. When you do sell it, you may qualify for the lower state and federal capital gains tax rates.

Nontaxable investments

Some investments pay returns that are not subject to state income tax, federal income tax or both. The best-known nontaxable investments are municipal bonds. The interest income from municipal bonds is generally exempt from federal income tax, and the interest also may be exempt from state income tax if you live in the state that issues the bonds.

An easy way to invest in municipal bonds is to buy shares in a municipal bond fund.

It’s important to compare your potential rate of return from a nontaxable investment with the amount you could earn in a taxable investment. Tax-free investments generally have lower returns.

Another example of a potentially nontaxable investment may be your personal residence. If you live in your home two years or longer, you may qualify to exclude $250,000 ($500,000 if married) from any profit from income taxes.

What are the benefits of deferring taxes?

At first glance, there may not appear to be much difference between paying taxes now and paying them later. The future value of your deferred-tax account will be higher than a comparable account on which you have been paying tax as you go. However, after you withdraw your money and pay state and federal income taxes, the difference in value is far less significant.

The major expected benefit of deferring taxes and paying them later is that you may be in a much lower tax bracket after you retire than during your working years. Say you have a 24 percent federal marginal tax rate and a 9.3 percent state marginal tax rate in California while you are working. That’s a total income tax rate of 33.3 percent of every additional dollar you make.

Even if you work part-time in your retirement, with a reduced income you may have a 22 percent federal marginal rate and a 6 percent California rate, for a total marginal tax rate of 28 percent. Paying tax later instead of now could save you even more in taxes if you move to a state with lower or no state income tax in retirement.

There is one additional benefit of starting and contributing to a traditional IRA to defer paying taxes. Being able to take an immediate tax deduction when you make an IRA contribution is very motivating. When you are preparing your tax return and you don’t like how much you owe, it’s usually not too late to contribute to an IRA for the previous tax year and lower that tax bill. That’s a good thing; the best retirement plan, after all, is the one you contribute to.

What are the downsides of using a tax-deferred retirement account?

One drawback is that contributions to IRA accounts are limited. If you want to create a traditional IRA account that will make a difference in your later years, it’s best to start early. Annual IRA contributions are limited to the higher of $6,500 per year in 2023 ($7,000 if age 50 or older) or your earned income.

Putting money in a tax-deferred IRA account could cost you money if you need the funds sooner. The Internal Revenue Service levies a 10 percent penalty on early withdrawals from traditional IRAs, with certain exceptions. On the other hand, investing in an account that carries a penalty if you take out the money early can be motivation to save retirement accounts for retirement.

Once you turn 73, you must start taking withdrawals from your traditional IRA or face stiff penalties from the IRS.

Which investment strategy should I choose: taxable, tax-deferred or nontaxable?

It can seem daunting to choose an investment or retirement plan. No single strategy is best for everyone. Here are some scenarios with suggested solutions:

You are a hands-on investor or day trader.

If you buy and sell investments and you want the most options for investments, stick to a brokerage or other investment vehicle. If you have the widest range of investments, such as collectibles or leveraged real estate, you probably won’t like the restrictiveness of a tax-deferred retirement account.

Most nontaxable investments are buy and hold, so they may not appeal to you.

On the other hand, if you are a stock day trader, consider doing most of your trading in a retirement account. You’ll have far less paperwork to deal with come tax filing time because you won’t have to report transactions from inside your retirement account.

You may need all your reserves for your business or other needs.

You can find tax-free, tax-deferred or taxable investments that allow you to access your money if needed. However, if you stand a good chance of needing your cash early, avoid putting it in a traditional IRA or other investment account that penalizes you for early withdrawal. You may also want to avoid investments like real estate, which you cannot quickly liquidate for cash.

You want to protect your retirement funds from creditors and collections.

Taxes aside, your traditional IRA or other retirement account may be safe from creditor claims, depending on the laws of your state, but check these laws to be sure.

You are currently in a lower tax bracket.

If you are starting a business, you have substantial tax deductions or you are offsetting losses, — or you’re in a low tax bracket for any other reason — you may not see much point in deferring taxes or making nontaxable investments. You are better off with investments that pay a better yield and reporting gains at your lower tax rate.

The general rule is to recognize gains and income in years when you have a lower marginal tax rate. You definitely do not want to accept lower investment yields — for example, those from municipal bonds — when you gain little benefit from their nontaxable status.

You are in a high income bracket, at least while you are working.

Consider tax-deferred investments. You still get a good rate of return, but you pay tax later. It’s far better to defer taxes when you may pay far, far less tax on every taxable dollar on your return later.

You will be in a high income bracket before and after retirement.

Tax-free investments may be a good bet for your portfolio. The higher your state and federal income tax bracket, the more advantageous nontaxable investments can be. With the highest marginal tax rates, savings on income taxes more than make up for the generally lower investment returns.