What does "tax deferred" mean in financial terms?

"Tax deferred" refers to investment income that is not taxed until it is withdrawn, typically at a later date. This means that any growth, interest, or dividends generated by the investment can accumulate without being subject to taxation in the interim. This feature is advantageous for investors as it allows their investment to grow more rapidly over time due to the compounding effect of the reinvested earnings that are not being diminished by annual taxes.

In many retirement accounts, such as traditional IRAs or 401(k)s, contributions might be made with pre-tax income, allowing the investments to grow tax-free until the individual withdraws funds during retirement, when they might be in a lower tax bracket. This strategy can be beneficial for long-term wealth accumulation, enabling investors to take full advantage of their investment's potential growth without the immediate tax burden.

This understanding distinguishes tax-deferred accounts from those where earnings are taxed each year, as well as from accounts that provide tax-free withdrawals, while also clarifying that tax-deferred means future taxation rather than exemption from all taxation.