What is the difference between a tax deduction and a tax deferral for retirement contributions?

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by daniela , in category: Taxation and Accounting , 9 months ago

What is the difference between a tax deduction and a tax deferral for retirement contributions?

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1 answer

by lynn.runolfsdottir , 9 months ago

@daniela 

A tax deduction and a tax deferral for retirement contributions are two different concepts that affect the timing of when the taxes are paid.

  1. Tax Deduction: A tax deduction allows individuals to reduce their taxable income for the year in which the contribution is made. This means that the contribution amount is deducted from their taxable income, resulting in a lower overall tax liability for that year. However, when distributions are taken from the retirement account in the future (typically during retirement), those distributions are subject to income tax at that time.
  2. Tax Deferral: A tax deferral allows individuals to defer paying taxes on the contributed amount and its investment gains until withdrawals are made from the retirement account later on, usually during retirement. This means that the contributed amount is not included in their taxable income for the year it is made, reducing their current tax liability. However, when distributions are taken in the future, the entire withdrawal (including both contributions and investment gains) is subject to income tax at that time.


In summary, a tax deduction reduces taxable income in the current year, while a tax deferral postpones the taxation of contributions and their investment gains to a later date when withdrawals are made.