Which of the Following Benefits Are Taxed at a Future Time?

Certain financial benefits allow you to defer taxes until a future date, often when funds are withdrawn in retirement. This can provide short-term tax advantages but may result in taxable income later. Understanding which benefits fall into this category is essential for effective financial planning.

Several types of retirement plans and investment products have tax-deferred features that impact when and how you pay taxes on them.

Employer-Sponsored Retirement Plans

Many workplace retirement plans let employees defer taxes on contributions and investment growth until withdrawal. These plans reduce taxable income during working years, with the expectation that withdrawals in retirement may be taxed at a lower rate. Each type of employer-sponsored plan has specific rules for contributions, distributions, and taxation.

401(k) Plans

A 401(k) is a retirement savings plan offered by private-sector employers that allows employees to contribute a portion of their wages pre-tax, lowering their taxable income. Employers often match contributions up to a certain percentage, increasing savings.

Funds grow tax-deferred, meaning investment earnings are not taxed annually. Taxes are due upon withdrawal, typically in retirement, and distributions are taxed as ordinary income. Withdrawals before age 59½ generally incur a 10% penalty unless an exception applies, such as disability or certain medical expenses.

Required minimum distributions (RMDs) must begin at age 73, as mandated by the SECURE 2.0 Act of 2022. The IRS calculates RMD amounts based on life expectancy and account balance.

403(b) Plans

A 403(b) plan operates similarly to a 401(k) but is designed for employees of public schools, nonprofit organizations, and religious institutions. Contributions are made pre-tax, reducing taxable income. Employers may contribute, though matching is less common than with 401(k) plans.

Like a 401(k), investment gains grow tax-deferred, and distributions are taxed as ordinary income. Early withdrawals before age 59½ usually incur a 10% penalty unless an exception applies. Employees with 15 or more years of service may make additional catch-up contributions beyond standard IRS limits.

RMDs begin at age 73. Certain 403(b) plans not subject to ERISA may have different administrative requirements, particularly for church-affiliated organizations.

457 Plans

A 457 plan is a tax-deferred retirement plan available to state and local government employees and some nonprofit workers. Contributions are made pre-tax, reducing taxable income. Unlike 401(k) and 403(b) plans, employer contributions to a 457(b) plan do not count toward an employee’s individual contribution limit, allowing for higher total savings.

A key distinction is that withdrawals upon separation from employment—regardless of age—do not incur the 10% early withdrawal penalty that applies to other retirement plans. However, distributions are still taxed as ordinary income.

457 plans also have a special catch-up provision. Employees within three years of the plan’s normal retirement age can contribute up to twice the standard annual limit.

RMDs are required at age 73 unless funds are rolled into another eligible retirement account. Governmental 457 plans offer more flexible withdrawal options than non-governmental 457 plans, which have stricter distribution rules.

Traditional IRAs

A Traditional Individual Retirement Account (IRA) allows individuals to save for retirement with tax-deferred growth. Contributions may be tax-deductible depending on income and whether the individual or their spouse is covered by a workplace retirement plan.

For 2024, full deductibility is available for single filers with a modified adjusted gross income (MAGI) of $77,000 or less if covered by an employer plan, with a phase-out range up to $87,000. For married couples filing jointly, the phase-out begins at $123,000 and ends at $143,000 if the contributing spouse is covered by a workplace plan.

Once funds are in a Traditional IRA, investments grow tax-deferred. Withdrawals are taxed as ordinary income in retirement. Early withdrawals before age 59½ generally incur a 10% penalty, with exceptions for qualified expenses such as first-time home purchases (up to $10,000), higher education costs, and unreimbursed medical expenses exceeding 7.5% of adjusted gross income.

RMDs must begin at age 73, per the SECURE 2.0 Act of 2022. The required withdrawal amount is based on the account balance and the IRS Uniform Lifetime Table. Failure to take RMDs results in a penalty of 25% of the amount not withdrawn, though this may be reduced to 10% if corrected within two years.

Nonqualified Deferred Compensation Plans

Nonqualified deferred compensation (NQDC) plans allow high-earning employees to defer income beyond standard retirement plan limits. These plans are typically used by executives to delay taxation on a portion of their earnings until retirement or separation from service.

NQDC plans fall under Internal Revenue Code Section 409A, which imposes strict rules on when and how deferred compensation can be distributed. Elections to defer income must be made before the year in which the compensation is earned, and distributions can only occur under specific circumstances, such as retirement, a fixed date, disability, or an unforeseen emergency. Failure to comply with these regulations can result in immediate taxation of all deferred amounts, a 20% additional tax penalty, and interest charges on underpaid taxes.

Unlike qualified retirement plans, NQDC funds are not held in a separate trust and remain part of the employer’s general assets. This means they are subject to creditor claims if the employer faces financial distress. Some companies use rabbi trusts to set aside funds for future payments, but these funds are still accessible to creditors.

Annuities

Annuities offer a tax-deferred way to generate income, often for retirement. Unlike traditional retirement accounts, annuities are issued by insurance companies and come in different types: fixed, variable, and indexed. Fixed annuities provide guaranteed returns, variable annuities fluctuate based on market performance, and indexed annuities tie returns to a market index like the S&P 500.

The tax treatment of annuities depends on whether they were purchased with pre-tax or after-tax dollars. Qualified annuities, often funded through rollovers from retirement accounts, are fully taxable upon withdrawal since contributions were tax-deferred. Nonqualified annuities, purchased with after-tax funds, are taxed only on the earnings portion of withdrawals, using a last-in, first-out (LIFO) method. This means earnings are withdrawn and taxed before any return of principal, which remains tax-free.

Withdrawals before age 59½ may incur a 10% early withdrawal penalty on taxable amounts.