What Is a Tax-Deferred Savings Plan? Types, Limits, and RMDs

A tax-deferred savings plan is a retirement account that lets you set aside money without paying income tax on your contributions or investment gains until you withdraw the funds, usually decades later. For 2026, you can contribute up to $24,500 to a 401(k) or similar employer plan, or up to $7,500 to a Traditional IRA, with higher limits if you’re 50 or older.¹ The tradeoff is straightforward: a tax break now and more room for your investments to grow, and the IRS collects its share when you eventually take the money out.

How the Tax Deferral Actually Works

Money you put into a tax-deferred account is subtracted from your taxable income for the year. Earn $80,000 and contribute $10,000 to your 401(k), and you’re only taxed on $70,000. The immediate payoff is a lower tax bill, but the real power is what happens next: every dollar that would have gone to taxes stays invested and earns returns of its own.

In a regular brokerage account, you’d owe taxes each year on dividends, interest, and capital gains. Inside a tax-deferred account, those earnings compound without annual tax drag. Over 20 or 30 years, that uninterrupted compounding is the core advantage.

This is a postponement, not a permanent tax break. When you withdraw the money in retirement, every dollar comes out as ordinary income and gets taxed at whatever rate applies to you that year. Most people bet their retirement tax rate will be lower than during peak earning years, which makes the deferral a good deal. Even if your rate stays flat, the decades of tax-free compounding usually leave you ahead.

Types of Tax-Deferred Accounts

Federal law creates several categories, each designed for a different employment situation. The differences affect how much you can contribute, who funds the account, and what withdrawal rules apply.

401(k) Plans

The 401(k) is the most common tax-deferred plan in the private sector. Your employer sets up the plan and you contribute through automatic payroll deductions before income taxes are calculated.² Many employers match a portion of your contributions. A common formula is 50 cents on the dollar up to 6% of your salary.

403(b) Plans

These work almost identically to 401(k) plans but are available to employees of public schools, churches, and organizations exempt from federal income tax under Section 501(c)(3).³ Teachers, hospital workers, and nonprofit staff typically access tax-deferred savings through a 403(b). Contribution limits and withdrawal rules match those of the 401(k).

Traditional IRAs

A Traditional IRA is an account you open on your own, independent of any employer. Anyone with earned income can contribute, though your ability to deduct contributions depends on your income level and whether you or your spouse participate in a workplace plan.⁴ Earned income means wages, salaries, tips, bonuses, and net self-employment income, not investment income like dividends or rental payments.⁵

SEP and SIMPLE IRAs

Self-employed people and small business owners have their own options. A SEP IRA allows employer-only contributions of up to 25% of an employee’s compensation, capped at $69,000 for 2026.⁶ There’s no employee salary deferral with a SEP; only the business contributes. A SIMPLE IRA, designed for businesses with 100 or fewer employees, flips this: employees can defer up to $17,000 of salary in 2026, and the employer must either match up to 3% of pay or make a flat 2% contribution for all eligible employees.

Traditional Versus Roth

The distinction trips up a lot of people. A traditional tax-deferred plan gives you a tax break today: contributions reduce this year’s taxable income, and you pay taxes when you withdraw. A Roth account (whether Roth 401(k) or Roth IRA) flips the order: you contribute money you’ve already paid taxes on, and qualified withdrawals in retirement come out completely tax-free.⁷

Neither approach wins universally. If you expect a lower tax bracket in retirement, traditional deferral usually pays because you’re shifting taxes from a high-rate year to a low-rate year. If you expect your rate to stay the same or climb, Roth contributions can come out ahead because you locked in today’s rate. Many people split the difference and contribute to both. The 2026 employee deferral limit of $24,500 applies to your combined traditional and Roth 401(k) contributions, not to each separately.¹

2026 Contribution Limits

The IRS adjusts caps annually for inflation. For 2026:¹

401(k), 403(b), and 457(b) plans: $24,500 in employee deferrals. Combined contributions (yours plus your employer’s) cannot exceed $72,000.⁸
Traditional and Roth IRAs: $7,500 combined across all your IRAs.⁹
SEP IRAs: up to 25% of compensation, maxing at $69,000.⁶
SIMPLE IRAs: $17,000 in employee deferrals.

Workers aged 50 and older can make catch-up contributions on top of the standard limits. For 401(k), 403(b), and 457(b) plans, the general catch-up is $8,000 in 2026, bringing total employee deferrals to $32,500. Under a change from the SECURE 2.0 Act, workers aged 60 through 63 get a higher catch-up of $11,250, for a total of $35,750.¹ For Traditional IRAs, the catch-up for those 50 and older is $1,100, for a total of $8,600.⁹

When Your Traditional IRA Deduction Phases Out

Anyone with earned income can contribute to a Traditional IRA, but the tax deduction isn’t guaranteed. If you or your spouse are covered by a retirement plan at work, your ability to deduct IRA contributions shrinks and eventually disappears as your income rises. The 2026 phase-out ranges based on modified adjusted gross income:

Single or head of household, covered by a workplace plan: $81,000 to $91,000.
Married filing jointly, you’re covered: $129,000 to $149,000.
Married filing jointly, only your spouse is covered: $242,000 to $252,000.
Married filing separately, covered by a workplace plan: $0 to $10,000.

Below the bottom of the range, you get the full deduction. Above the top, none. In between, the deduction is prorated. If you earn too much to deduct, you can still make nondeductible IRA contributions, though at that point a Roth IRA is usually the better call, since both lose the upfront deduction but only Roth gives you tax-free withdrawals later.

Early Withdrawal Penalties and Exceptions

Pulling money from a tax-deferred account before age 59½ triggers a 10% additional tax on top of the regular income tax you’ll owe on the withdrawal. If you withdraw from a SIMPLE IRA within your first two years of participation, the penalty jumps to 25%.¹⁰

Congress has carved out a long list of exceptions where the 10% penalty doesn’t apply, though you’ll still owe regular income tax on the distribution. The most commonly used exceptions:

Total and permanent disability of the account owner.
Death (distributions to beneficiaries after the owner dies).
Substantially equal periodic payments, a series of fixed withdrawals calculated over your life expectancy, sometimes called 72(t) payments. Once you start, you must continue for at least five years or until you reach 59½, whichever comes later.¹¹
Unreimbursed medical expenses exceeding 7.5% of your adjusted gross income.
First-time home purchase, up to $10,000 from an IRA (not available from 401(k) plans).
Qualified higher education expenses, from IRAs only.
Birth or adoption, up to $5,000 per child.
Federally declared disaster, up to $22,000.

One exception catches people off guard because it applies only to employer plans: if you leave your job during or after the year you turn 55, you can take distributions from that employer’s plan without the 10% penalty.¹² This is sometimes called the “Rule of 55.” It doesn’t apply to IRAs, and it only covers the plan at the employer you’re leaving, not old 401(k)s sitting at previous employers.

Required Minimum Distributions at 73

Tax deferral doesn’t last forever. Starting at age 73, you must begin taking required minimum distributions from your traditional tax-deferred accounts every year.¹³ Under the SECURE 2.0 Act, this age increases to 75 beginning January 1, 2033, benefiting anyone born in 1960 or later. The IRS calculates your annual RMD by dividing your account balance by a life expectancy factor from its published tables.

Missing an RMD is expensive. The penalty is 25% of the amount you should have withdrawn but didn’t. If you catch the mistake and take the distribution within two years, the penalty drops to 10%.¹³ Retirees often stumble in their first RMD year. You have until April 1 of the year after you turn 73 to take your first distribution, but waiting means two distributions in that second year (the delayed first plus the current year’s), which can push you into a higher tax bracket.

Rolling Over When You Change Jobs

When you leave an employer, the money in your 401(k) or 403(b) doesn’t have to stay there. The cleanest move is a direct rollover, where your old plan sends the funds straight to your new employer’s plan or to an IRA. No taxes are withheld and no penalties apply.¹⁴

If the distribution is paid directly to you instead, your old plan is required to withhold 20% for federal taxes, even if you intend to roll the full amount over. You then have 60 days to deposit the full distribution amount (including making up the withheld 20% from your own pocket) into a new plan or IRA. Deposit less than the full amount and the shortfall is treated as a taxable distribution, plus the 10% early withdrawal penalty if you’re under 59½. For IRA-to-IRA rollovers, watch the one-per-year rule: you’re limited to one indirect rollover across all your IRAs in any 12-month period.¹⁴ Direct trustee-to-trustee transfers don’t count toward this limit.

How Distributions Are Taxed

Every dollar you withdraw from a tax-deferred account is taxed as ordinary income in the year you receive it, at whatever federal bracket applies to your total income that year. For distributions paid directly from an employer plan like a 401(k), the custodian withholds 20% for federal income tax automatically.¹⁵ That withholding is an estimate. If your actual tax rate is higher, you’ll owe more at filing time; if lower, you’ll get a refund. IRA distributions have different default withholding rules and you can typically elect how much to have withheld.

State income taxes add another layer. Most states tax retirement distributions as ordinary income, though a handful have no income tax at all and others offer partial exemptions for pension or retirement income. Your actual tax burden in retirement depends heavily on where you live.

1
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
2
Office of the Law Revision Counsel. 26 U.S. Code 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans
3
Office of the Law Revision Counsel. 26 U.S. Code 403 – Taxation of Employee Annuities
4
Internal Revenue Service. Topic No. 451, Individual Retirement Arrangements (IRAs)
5
Office of the Law Revision Counsel. 26 U.S. Code 408 – Individual Retirement Accounts
6
Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs)
7
Internal Revenue Service. Roth Comparison Chart
8
Internal Revenue Service. Notice 25-67 – 2026 Amounts Relating to Retirement Plans and IRAs
9
Internal Revenue Service. Retirement Topics – IRA Contribution Limits
10
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
11
Internal Revenue Service. Substantially Equal Periodic Payments
12
Internal Revenue Service. Topic No. 558, Additional Tax on Early Distributions From Retirement Plans Other Than IRAs
13
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
14
Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
15
Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules