How to Defer Income With Key Financial Strategies

Income deferral is a financial strategy designed to postpone the payment of income taxes to a future date. This approach can be particularly beneficial for individuals who anticipate being in a lower tax bracket in later years, such as during retirement. By deferring income, taxpayers can potentially reduce their current year’s taxable income, thereby lowering their immediate tax liability.

Understanding Income Deferral

Income deferral centers on delaying when income is recognized for tax purposes. This strategy allows money to grow on a tax-deferred basis, meaning investment gains are not taxed until withdrawn. The primary advantage is the potential to pay taxes at a lower rate in the future, especially if an individual expects their income or tax bracket to decrease, such as in retirement.

The general idea is to shift taxable income from a year when an individual is in a higher tax bracket to a year when they expect to be in a lower one. This allows the deferred funds to compound over time without being eroded by annual taxation. Taxes will eventually be paid on these deferred amounts upon withdrawal.

Qualified Retirement Accounts

Qualified retirement accounts are a common and effective method for income deferral. Contributions made to these accounts are typically tax-deductible in the year they are made, reducing current taxable income. Investment growth within these accounts also occurs on a tax-deferred basis, with taxes paid only when funds are withdrawn, usually in retirement.

401(k) and 403(b) Plans

Employer-sponsored plans like 401(k)s and 403(b)s allow employees to contribute a portion of their salary on a pre-tax basis. For 2025, the annual contribution limit for employees participating in 401(k), 403(b), and most 457 plans is $23,500. Individuals aged 50 and over can make additional “catch-up” contributions, which for 2025 is $7,500, increasing their total contribution to $31,000. A higher catch-up contribution of $11,250 applies to those aged 60-63 in these plans. These plans are established under Internal Revenue Code (IRC) Section 401.

Withdrawals from these accounts are generally taxed as ordinary income in retirement. Taking distributions before age 59½ typically incurs a 10% penalty in addition to ordinary income taxes, though certain exceptions apply.

Traditional IRAs

Traditional Individual Retirement Arrangements (IRAs) are governed by Internal Revenue Code (IRC) Section 408 and allow individuals with earned income to contribute on a pre-tax basis. For 2025, the annual contribution limit for Traditional IRAs is $7,000 for those under age 50. Individuals aged 50 and older can contribute an additional $1,000 as a catch-up contribution, bringing their total to $8,000.

The tax deductibility of Traditional IRA contributions may be limited if an individual or their spouse is covered by a retirement plan at work, depending on their modified adjusted gross income (MAGI) and filing status. Distributions in retirement are taxed as ordinary income, and early withdrawals before age 59½ may be subject to a 10% penalty.

SEP IRAs

Simplified Employee Pension (SEP) IRAs are retirement plans primarily for self-employed individuals and small business owners. Contributions to a SEP IRA are made by the employer, even if the employer is the self-employed individual. For 2025, employers can contribute the lesser of 25% of an employee’s compensation or $70,000. The maximum compensation that can be considered for these contributions is $350,000 for 2025.

SEP IRAs do not allow employee contributions or catch-up contributions for those aged 50 and over. All contributions are tax-deductible for the employer, and earnings grow tax-deferred until retirement. This plan offers considerable flexibility as contributions are not required every year and can vary based on business profitability.

SIMPLE IRAs

Savings Incentive Match Plan for Employees (SIMPLE) IRAs are retirement plans for small businesses with 100 or fewer employees. Employees can make pre-tax salary reduction contributions, and employers are generally required to make either matching contributions or fixed non-elective contributions. For 2025, the employee contribution limit for SIMPLE IRAs is $16,500.

Individuals aged 50 and over can make an additional catch-up contribution of $3,500, bringing their total to $20,000. For those aged 60-63, a higher catch-up contribution of $5,250 may apply. These contributions reduce current taxable income, and the funds grow tax-deferred until withdrawal in retirement.

Health Savings Accounts

Health Savings Accounts (HSAs) are governed by Internal Revenue Code (IRC) Section 223 and serve as an income deferral tool, offering a “triple tax advantage.” HSAs allow for pre-tax contributions, tax-deferred growth, and tax-free withdrawals when used for qualified medical expenses.

To be eligible for an HSA, an individual must be enrolled in a High-Deductible Health Plan (HDHP). For 2025, an HDHP must have an annual deductible of at least $1,650 for self-only coverage or $3,300 for family coverage. The out-of-pocket maximums cannot exceed $8,300 for self-only coverage and $16,600 for family coverage.

For 2025, the HSA contribution limit is $4,300 for self-only coverage and $8,550 for family coverage. Individuals aged 55 and older can contribute an additional $1,000 as a catch-up contribution. HSA funds roll over from year to year, do not have a “use it or lose it” rule, and can be invested for potential growth. After age 65, withdrawals for non-medical expenses are taxed as ordinary income, but remain tax-free if used for qualified medical costs.

Non-Qualified Deferred Compensation

Non-qualified deferred compensation (NQDC) plans are contractual agreements between an employer and an employee to defer a portion of the employee’s compensation to a future date. Unlike qualified plans, NQDC plans are not subject to the extensive regulations of the Employee Retirement Income Security Act (ERISA) or the same contribution limits found in qualified retirement accounts. This flexibility allows for deferral of income beyond the limits of qualified retirement accounts, making them attractive to highly compensated employees.

Income is not taxed until it is actually received by the employee, even if the work generating the income was performed much earlier. Employers offer these plans to retain key talent, as the deferred compensation often vests over time.

A significant distinction from qualified plans is that NQDC assets are generally not held in a separate trust for the employee’s benefit. Instead, the deferred amounts remain part of the employer’s general assets and are subject to the employer’s creditors in the event of bankruptcy or financial distress. This introduces a risk of potential loss for the employee, which is not present in qualified plans.

Strategic Income and Expense Timing

Strategic timing of income and expenses is a tax planning technique that involves controlling when certain financial transactions occur to manage tax liability across different years. This approach is particularly relevant for self-employed individuals, small business owners, and those with control over the receipt of income or payment of expenses.

One common strategy is to defer income. For example, if a taxpayer anticipates being in a lower tax bracket in the following year, they might delay billing or collecting payments until after the current tax year ends. This method is often most effective for individuals and businesses using the cash method of accounting, where income is recognized when cash is received.

Conversely, accelerating expenses involves paying deductible expenses before the current tax year ends. This could include prepaying certain business expenses, making charitable contributions, or paying property taxes. This strategy is beneficial when a taxpayer expects to be in a higher tax bracket in the current year compared to the next, or if they wish to maximize deductions against current income.