When planning for retirement, it’s important to consider how you want your investments to grow over time. There are many retirement vehicles to choose from, including IRAs and 401(k)s, but generally, they fall into two buckets: tax-free or tax-deferred.

But what is tax-deferred growth compared to tax-free growth, and how do you decide which type of account is best for you?

We’ll break down the key differences between tax-deferred and tax-free accounts, how each one works, and what to consider when choosing between them. Whether you’re just starting to save or fine-tuning your long-term plan, understanding how your money grows can help you make smarter decisions for your future.

What is Tax-Deferred?

Tax-deferred investment accounts, like Traditional IRAs and 401(k)s, allow for pre-tax contributions that grow tax-free while in your account. Further, you won’t pay taxes on gains, dividends, or interest until you begin taking withdrawals in retirement.

In other words, your tax obligations are delayed until retirement, at which point withdrawals will be subject to your income tax rate.

When you make withdrawals in retirement, the distribution is taxed at your current income tax rate. As such, tax-deferred accounts are often a good option if you expect to be in a lower tax bracket after you retire.

What is Tax-Free?

While Traditional IRAs offer tax-deferred growth, Roth IRAs or 401(k) Roth Buckets provide tax-free growth. Contributions are made with after-tax dollars, so you won’t need to pay taxes upon withdrawal.

Gains, dividends, and interest also grow tax-free. As such, a tax-free account may be a good option if you think you’ll be in a higher tax bracket during retirement.

What’s the Difference?

While both traditional (tax-deferred) and Roth (tax-free) accounts are designed to help you save for retirement, they differ in how contributions are taxed, how the money grows, and how withdrawals are handled.

Traditional IRA; Tax-Deferred Growth

• Tax treatment. Contributions are typically tax-deductible, which means you may get a break on your taxes in the year you contribute.
• Growth. Your investments and earnings grow tax-free until you withdraw money from the account.
• Withdrawals. You can begin taking qualified withdrawals at the age of 59 ½. Those withdrawals are taxed as ordinary income.
• Required minimum distributions (RMDs). You must begin taking RMDs starting at age 73.

Roth IRA: Tax-Free Growth

• Tax treatment. Contributions are made with after-tax dollars, so there are no upfront tax deductions.
• Growth. Contributions and earnings grow tax-free.
• Withdrawals. Qualified withdrawals after age 59 ½ are not taxed. Withdrawals from contributions are tax and penalty-free.
• Required minimum distributions (RMDs). Roth accounts are not subject to RMDs.

Tax-Free vs. Tax-deferred: Which Should I Choose?

Before selecting, consider what you are looking to get out of your retirement fund. Each tax-advantaged IRA has its perks. Your decision can also be shaped by your financial situation and how you want your money to grow.

Traditional IRAs can benefit those with more money to set aside. They can receive tax breaks on their contributions and let their money grow tax-deferred. This works well, especially if you will be in a lower tax bracket come retirement.

On the other hand, if you have less money to start, a Roth account is an excellent choice. Your taxes are paid up-front, so you don’t have to worry about paying anything on them later.

Your withdrawals are made tax-free. Since your taxes were paid upfront, Roth account withdrawals are not taxable. Additionally, there are no required minimum distributions, so your account can continue to grow, tax-free.

Contributions can be withdrawn at any time, but earnings before 59 ½ or for accounts opened less than 5 years may encounter an early withdrawal penalty.

Regardless of your choice, your account will experience long-term growth for a comfortable retirement.

Choosing the Right Strategy for Long-Term Growth

There’s no one-size-fits-all approach to retirement planning, and selecting the best path often requires you to evaluate the pros and cons of each type of account as they relate to your current financial situation and future retirement goals.

Before you commit to either option, take time to evaluate the following:

• Your current and expected future tax bracket. Will you be in a lower or higher tax bracket in retirement? If the answer is lower, a traditional account offering tax-deferred benefits may be your best option. Consider a Roth account if you’ll be in a higher tax bracket.
• Your income eligibility. Roth IRAs have contribution limits based on your income and tax-filing status. If you’re above the threshold, your contributions may be limited or phased out. A traditional account has no income limits; only earned income is required.
• Desire for flexibility. Consider a Roth account if you want more control over when and how you can access your money. Generally, these accounts allow you to make penalty-free withdrawals on contributions, and there are no RMDs.
• Your long-term legacy goals. Funds in a Roth account can continue to grow tax-free without RMDs, so you can keep them and pass them on to heirs. If legacy planning is central to your decision, consider a Roth.

Whatever path you choose, the key is starting early, staying consistent, and making decisions based on your financial situation. Tax-deferred and tax-free accounts both offer powerful growth potential, but the right fit comes down to how and when you want to access your money and what kind of tax treatment makes sense for your future.

Before making any decisions, consult a Horizon Trust financial consultant to review your options. With the right guidance and thoughtful planning, you can build a strong foundation for retirement and feel confident about your future.

FAQs

What happens if I withdraw early?

Both types of accounts can impose penalties if you take funds before age 59½, with some exceptions (such as first-time home purchases, qualified education expenses, or medical costs). Only earnings in a Roth account are penalized and must follow the 5-year rule–all contributions can be withdrawn at any point without penalty.

​​Which is better for estate planning?

Tax-free accounts (like Roth IRAs) can be advantageous because heirs can withdraw without paying income tax, though rules on inherited accounts apply.

When do I pay taxes on Roth and Traditional accounts?

• Tax-deferred: Taxes are due upon withdrawal, typically at your ordinary income tax rate.
• Tax-free: Taxes are paid upfront. No taxes are due on qualified withdrawals.