December 4, 2014 Admin | December 4, 2014 What is the difference between tax deferred vs. tax exempt? Examples? Why should you care?
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Tax deferred investment are investments that you don’t pay taxes on a latter date. Examples of this are dividends and capital gains. You should care because with this you can let your investment grow unhindered. Something that is tax exempt is free from regulators or government entities. Interest earned from municipal bonds are tax exempt. You should care because you want to be able to pay as little in taxes as you can.
Tax differed means that you are pushing the taxes off until latter. A traditional retirement account would be tax differed because you will still pay taxes on those gains at a latter date. Tax exempt income is income you never pay taxes on such as social security, higher education grants, municipal bonds and food stamps. You should know the difference because you could benefit from using one or the other. Tax exempt is better but you can still use tax deferred to your advantage.
You made many fine points, gentlemen. Let’s review.
Tax deferred moves you taxes to a later date. A company retirement plan like a traditional 401(k) is a good example. The value of doing this provides your earnings (your money making money) an opportunity to grow without taxation at that time. The time value of money shows us how this can create wealth over time as you delay the tax man until years if not decades later.
Tax exempt deals with certain investments that you pay no tax now (municipal bonds for example) and it can also apply to earnings in a Roth IRA or 401(k). If you follow the 5 year rule (earnings are not touched for 5 years before withdrawal and you are beyond 59.5 years old), your earnings will be tax free when you pull the money out later in life for your future needs.
Focus on both issues as you delay, delay, and delay in paying tax on your investments. Tax deferred is good, tax exempt/tax free is great. Educate and ACT!!!!!!