What does the term "tax-deferred" refer to?

The term "tax-deferred" refers to an investment option where taxes on earnings are postponed. In a tax-deferred account, such as a traditional IRA or 401(k), the income and capital gains generated within the account are not subject to taxation until the funds are withdrawn. This allows the investment to grow more quickly since the money that would have gone to taxes can instead remain in the account and compound over time.

This characteristic benefits investors, as they can take advantage of compounding growth without the immediate burden of taxation. It is particularly advantageous for retirement savings, where individuals can potentially remain in a lower tax bracket when they retire and withdraw the funds, thereby paying less tax overall than if they had been taxed during the accumulation phase.