What is meant by "tax deferral"?

Tax deferral refers to the postponement of taxation on earnings until a later date. This concept is prominently applied in retirement accounts, such as 401(k)s or IRAs, where the contributions made to these accounts are not taxed immediately. Instead, taxes are deferred until the individual withdraws funds, typically during retirement when they may be in a lower tax bracket.

This strategy allows individuals to potentially grow their investments without the immediate burden of taxation, ultimately enhancing the compounding effect on investments over time. By deferring taxes, not only do individuals benefit from potentially lower tax rates in the future, but they also have the opportunity to allocate more funds towards investment growth in their accounts, leading to potentially greater returns when they do start withdrawing in retirement.