What Is Tax-Deferred? Accounts, Limits, and Withdrawals

Tax-deferred means you don’t pay income tax on money you put into certain accounts, or on what it earns, until you take it out. The most common tax-deferred accounts are 401(k)s, 403(b)s, governmental 457(b)s, and Traditional IRAs. For 2026, you can defer up to $24,500 through an employer plan or $7,500 through an IRA before any federal income tax is owed on that money.¹ The tradeoff is simple: your balance compounds without an annual tax drag, but every dollar you eventually withdraw is taxed as ordinary income at whatever rate applies then.

How Tax Deferral Works

When you contribute pre-tax dollars to a qualified retirement account, those dollars come out of your gross income for the year. Earn $80,000 and put $10,000 into a Traditional 401(k), and you report $70,000 in income to the IRS. The $10,000, along with any dividends, interest, and capital gains it generates inside the account, sits untouched by federal income tax until you begin taking distributions.

The compounding effect is the reason these accounts exist. In a taxable brokerage account, you owe tax each year on dividends and realized gains, which reduces what stays invested. Inside a tax-deferred account, that annual drag disappears. A balance earning the same return over twenty years finishes noticeably larger when nothing is siphoned off along the way.

Whether deferral actually saves you money depends on your bracket now versus your bracket when you withdraw. If you’re in a high bracket while working and expect a lower one in retirement, deferral works in your favor: you skip the tax at 32% and pay it later at 12% or 22%. If you’re early in your career at a low rate and expect a higher rate later, a Roth account (tax paid now, withdrawals tax-free) may produce a better after-tax result. Most people benefit from holding both types, because no one can predict future tax rates with certainty.

Which Accounts Are Tax-Deferred

401(k) and 403(b) Plans

The 401(k) is the most widely available tax-deferred account, offered by private-sector employers. A portion of each paycheck is deposited into the account before income tax withholding, and many employers match a percentage of your contributions. The 403(b) works nearly identically but is available only to employees of public schools and organizations that are tax-exempt under Section 501(c)(3), such as hospitals, charities, and religious organizations.² Both follow the same contribution limits and early withdrawal rules.

Governmental 457(b) Plans

State and local government employees often have access to a 457(b) plan instead of, or in addition to, a 401(k). Contribution limits mirror the 401(k), but distributions taken before age 59½ are not subject to the 10% early withdrawal penalty, as long as the money wasn’t rolled in from a different plan type.³ That makes 457(b) accounts especially useful for anyone planning to retire before 59½.

Traditional IRAs

A Traditional Individual Retirement Account is available to anyone with earned income, whether or not they have a workplace plan. Contributions may be tax-deductible depending on your income and whether you or your spouse participate in an employer-sponsored plan.⁴ When the contribution is deductible, the IRA behaves exactly like a 401(k): pre-tax money in, ordinary income tax on the way out. Even when a contribution isn’t deductible because your income exceeds the phase-out range, the earnings inside still grow tax-deferred until withdrawal.

Tax-Deferred Annuities

Insurance companies sell annuity contracts that offer tax-deferred growth without the contribution caps of employer plans or IRAs. You typically fund an annuity with after-tax dollars, so there’s no upfront deduction, but the earnings compound untaxed until payments begin.⁵ When distributions start, only the earnings portion is taxable; your original investment comes back tax-free because you already paid tax on it. These contracts often carry higher fees than retirement plan investments, so the tax benefit has to outweigh the cost.

2026 Contribution Limits

The IRS adjusts contribution caps for inflation each year. For 2026:

401(k), 403(b), and governmental 457(b) plans: $24,500 in employee elective deferrals. Workers age 50 and older can add an $8,000 catch-up, for a total of $32,500. Workers aged 60 through 63 qualify for an enhanced catch-up of $11,250 instead of $8,000, bringing their ceiling to $35,750.¹
Total annual additions (employee plus employer contributions): $72,000 across all defined contribution plans with the same employer.⁶
Traditional and Roth IRAs: $7,500, or $8,600 if you’re 50 or older.⁷

For Traditional IRAs, the deduction phases out at certain income levels if you or your spouse are covered by a workplace plan. In 2026, single filers covered by a workplace plan lose part of the deduction between $81,000 and $91,000 in modified adjusted gross income. Married couples filing jointly face a phase-out between $129,000 and $149,000 when the contributing spouse has workplace coverage, or between $242,000 and $252,000 when only the non-contributing spouse is covered.¹ Above those ranges, you can still contribute to a Traditional IRA; the contribution just won’t reduce your taxable income.

How Withdrawals Are Taxed

When you withdraw from a tax-deferred account, the IRS treats the money as ordinary income, not capital gains. It’s taxed at your marginal rate, which for 2026 ranges from 10% to 37% depending on total taxable income.⁸ If everything you contributed was pre-tax, the entire withdrawal is taxable. If some contributions were nondeductible, only the earnings portion is taxed, but tracking that requires filing Form 8606 in each year you made nondeductible contributions.

Every plan administrator or IRA custodian that processes a distribution of $10 or more issues Form 1099-R, which reports the gross amount, the taxable amount, and any federal tax withheld.⁹ You report this income on your federal return for the year you received the distribution.

Rollovers

Moving money from one tax-deferred account to another doesn’t trigger tax if you follow the rules. The cleanest method is a direct rollover, sometimes called a trustee-to-trustee transfer, where funds move between institutions without passing through your hands. No withholding applies and there’s no time pressure.¹⁰

If the distribution is paid to you instead, you have 60 days to deposit it into another eligible retirement account. Miss that window and the full amount becomes taxable income for the year, plus the 10% early withdrawal penalty if you’re under 59½. For distributions from employer plans, the administrator must withhold 20% for federal taxes, so you’d need to make up that 20% from other funds to roll over the full amount. IRA-to-IRA rollovers also carry a once-per-year limit; you can only do one indirect rollover across all your IRAs in any 12-month period. Direct transfers between trustees are exempt from that limit.¹⁰

Roth Conversions

You can convert tax-deferred funds in a Traditional IRA or eligible employer plan into a Roth IRA, but the converted amount is added to your taxable income for the year.¹¹ There’s no income limit on conversions and no cap on the amount. Once the money is in a Roth, it grows tax-free and qualified withdrawals in retirement owe nothing. The cost is a potentially large tax bill in the year you convert. This strategy tends to make the most sense in years when your income is unusually low, such as a gap between jobs or early retirement before Social Security begins.

Early Withdrawal Penalty and Exceptions

Pull money from a tax-deferred account before age 59½ and you’ll generally owe a 10% additional tax on top of ordinary income tax.³ On a $50,000 withdrawal in the 22% bracket, the penalty adds $5,000 to $11,000 in income tax, cutting what you actually keep to $34,000.

Several circumstances avoid the 10% penalty, though ordinary income tax still applies:

Separation from service after age 55. If you leave your job during or after the year you turn 55, distributions from that employer’s plan are penalty-free. For qualified public safety employees, the age drops to 50. This exception applies only to employer plans, not IRAs.³
Total and permanent disability within the IRS definition, from any tax-deferred account.
Unreimbursed medical expenses exceeding 7.5% of your adjusted gross income, up to that excess amount.
First-time home purchase, up to $10,000 from an IRA.
Qualified higher education expenses at eligible institutions, from an IRA.
Distributions from an employer plan to an alternate payee under a qualified domestic relations order in a divorce.

If none of the standard exceptions fit, you can still access funds before 59½ through substantially equal periodic payments, often called a 72(t) or SEPP plan. You commit to withdrawing a fixed annual amount based on your life expectancy, using one of three IRS-approved calculation methods. The commitment is serious. Once you begin, you cannot change the payment amount or contribute more to the account. The schedule must continue until the later of five full years or the date you reach 59½. Modify the payments early, even once, and the IRS imposes the 10% penalty retroactively on every distribution taken since the SEPP began, plus interest.¹²

Required Minimum Distributions

The government eventually wants the tax revenue it deferred, so federal law requires you to begin withdrawing from most tax-deferred accounts at age 73.¹³ These required minimum distributions apply to Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, and most other employer-sponsored plans. Roth IRAs have no RMDs during the owner’s lifetime.

The annual RMD is calculated by dividing your account balance as of December 31 of the prior year by a life expectancy factor from the IRS Uniform Lifetime Table.¹⁴ If your IRA held $100,000 at year-end and the table shows a distribution period of 24.6, your RMD would be roughly $4,065. The factor shrinks as you age, so RMDs grow as a percentage of your balance over time.

Missing an RMD triggers an excise tax of 25% of the amount you should have taken. Catch the error and withdraw the missed amount within two years, and the penalty drops to 10%.¹³

Inherited Tax-Deferred Accounts

When the owner of a tax-deferred account dies, the rules for the beneficiary depend on who they are. A surviving spouse who is the sole beneficiary can roll the inherited account into their own IRA and treat it as if it had always been theirs, resetting the RMD clock to their own age and eliminating any forced withdrawal schedule until they reach 73.¹⁵

Non-spouse beneficiaries face a tighter timeline. For account owners who died in 2020 or later, most designated beneficiaries must empty the entire inherited account by the end of the tenth year following the year of death.¹⁵ There is no annual minimum during those ten years. You can take it all in year one, spread it evenly, or wait until year ten, but the full balance must be distributed and taxed by the deadline. A small group of eligible designated beneficiaries can still stretch distributions over their own life expectancy: minor children of the deceased until they reach the age of majority, people with disabilities or chronic illness, and beneficiaries not more than ten years younger than the deceased owner.

Every dollar distributed counts as ordinary income to the beneficiary, and concentrating large withdrawals into a single year can push you into a higher bracket. Spreading distributions across the ten-year window is usually the smarter approach, but it requires planning.

State Taxes Are Separate

Federal tax is only part of the picture. Most states with an income tax also treat retirement distributions as taxable income, though the rules vary widely. Several states have no personal income tax at all. Others exempt some or all retirement income for residents who have reached a qualifying age. A handful tax retirement distributions at the same rate as any other income with no special treatment. If you’re choosing where to retire, the state-level tax treatment of your 401(k) and IRA withdrawals can amount to thousands of dollars a year, and it’s worth checking before you commit to a location.

1
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
2
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3
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7
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8
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9
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Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
11
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12
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13
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14
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15
Internal Revenue Service. Retirement Topics – Beneficiary