- Strength of Retirement System
- Retirement Plans: Workers’ Access
- Understanding Tax-Deferred Benefits
- Fees in Retirement Plans
- Retirement Policy Issues
- Participant Education
- More ICI Retirement Resources
Tax-Deferred, Not Tax-Free
Commentators frequently refer to the “tax-free” treatment of retirement savings, equating retirement-savings contributions to employer-paid health benefits (which are excluded from income) and mortgage interest (which is deducted from income). Such commentators assert that, for example, the tax savings from a $1 tax-deferred contribution is 3.5 times greater for a taxpayer in the 35 percent tax bracket than for a taxpayer in the 10 percent bracket.
Such assertions are incorrect. Unlike income that is excluded or deducted from taxes, deferred compensation is eventually taxed when it is withdrawn from a retirement account—meaning that the benefits of tax deferral cannot be calculated in the same way as benefits of an exclusion or deduction. The benefits calculation for tax-deferred compensation, such as 401(k) contributions, is not just a function of the individual’s marginal tax rate; it’s also one that involves the uncertain effects of time and rates of return.