When you hear “tax-deferred accounts,” you might think you’re getting a great deal. You put off paying taxes now, and your money grows faster. But not every tax-deferred account is a win. Some can actually cost you more in the long run. Fees, tax rates, and withdrawal rules can eat into your savings. If you’re not careful, you could end up with less money than if you’d just paid taxes upfront. Here’s what you need to know about tax-deferred accounts that might not be as good as they seem.
1. Traditional 401(k) Plans with High Fees
A traditional 401(k) is the most common tax-deferred account. You don’t pay taxes on your contributions or growth until you withdraw the money. But many 401(k) plans come with high administrative fees and expensive investment options. Over time, these fees can take a big bite out of your savings. If your employer’s plan charges more than 1% in annual fees, you could lose tens of thousands of dollars over your career. Always check your plan’s fee structure. If it’s too high, consider rolling over to an IRA with lower costs.
2. Variable Annuities
Variable annuities are often sold as tax-deferred investments for retirement. The pitch is that your money grows tax-free until you take it out. But these products are loaded with fees—mortality charges, administrative costs, and investment management fees. Some also have surrender charges if you withdraw early. The tax deferral might sound good, but the fees can easily outweigh the benefits. Plus, when you finally withdraw, you pay ordinary income tax, not the lower capital gains rate. For most people, there are better ways to invest for retirement.
3. Non-Deductible Traditional IRAs
A non-deductible traditional IRA lets you put in after-tax money, but the growth is tax-deferred. The problem? When you withdraw, you pay taxes on the earnings at your ordinary income rate. You also have to keep careful records to avoid double taxation on your contributions. The paperwork is a hassle, and the tax treatment isn’t great. Roth IRAs, which offer tax-free growth and withdrawals, are usually a better choice if you qualify.
4. Deferred Compensation Plans
Some employers offer deferred compensation plans to high earners. You put off receiving part of your salary until retirement, and you don’t pay taxes until then. But these plans are risky. If your employer goes bankrupt, you could lose everything. Plus, you have no control over the money until you retire or leave the company. The tax deferral might not be worth the risk, especially if you’re already maxing out other retirement accounts.
5. Tax-Deferred Whole Life Insurance
Whole life insurance is sometimes sold as a tax-deferred savings vehicle. The cash value grows tax-deferred, and you can borrow against it. But the fees are high, and the returns are usually low compared to other investments. You’re also paying for insurance you might not need. If you want to invest for retirement, there are better options than using a life insurance policy as a tax-deferred account.
6. 457(b) Plans with Limited Investment Choices
457(b) plans are tax-deferred accounts for government and some nonprofit workers. They can be a good deal, but some plans have limited investment options and high fees. If your plan only offers a handful of expensive funds, your growth will suffer. Always compare your 457(b) plan’s fees and investment choices to other options. Sometimes, it’s better to use a 403(b) or IRA instead.
7. Health Savings Accounts (HSAs) Used for Non-Qualified Expenses
HSAs are tax-deferred accounts with triple tax benefits if used for medical expenses. But if you use the money for non-qualified expenses before age 65, you pay taxes and a 20% penalty. Even after 65, non-medical withdrawals are taxed as ordinary income. If you’re not using your HSA for health costs, you might be better off with a Roth IRA or other account. Don’t treat your HSA like a regular retirement account unless you’re sure you’ll use it for medical expenses.
8. Education Savings Accounts with High Fees
Coverdell Education Savings Accounts (ESAs) and some 529 plans offer tax-deferred growth for education expenses. But not all plans are created equal. Some have high management fees or limited investment choices. Over time, these costs can eat into your savings. Always compare fees and performance before choosing a tax-deferred education account. A low-cost 529 plan from another state might be a better deal.
9. Employer Stock Purchase Plans (ESPPs) with Deferral Features
Some ESPPs let you defer taxes on gains until you sell the stock. But holding too much company stock is risky. If your company’s value drops, you could lose both your job and your savings. Plus, when you finally sell, you might pay higher taxes than if you’d sold earlier. Diversifying your investments is usually safer than deferring taxes on company stock.
Rethink Your Tax-Deferred Strategy
Tax-deferred accounts can help you save for the future, but they’re not all created equal. High fees, poor investment choices, and complicated rules can cost you more in the long run. Before you put your money in any tax-deferred account, look at the fees, risks, and tax treatment. Sometimes, paying taxes now and choosing a simpler account is the smarter move. Make sure your strategy fits your goals, not just the promise of tax deferral.
What’s your experience with tax-deferred accounts? Have you run into any hidden costs or surprises? Share your story in the comments.
Read More
What Tax Preparers Aren’t Warning Pre-Retirees About in 2025
How These 5 States Are Taxing Retirement Income Twice
The post 9 Tax-Deferred Accounts That Cost More in the Long Run appeared first on The Free Financial Advisor.
