Tax Deferral is a crucial tax concept and the reason why retirement accounts are such a powerful investment vehicle. Tax deferral occurs when you use a specially designated account, or investment option, that does not require you to claim the investment income earned inside of the account every year on your tax return. Instead, you get to defer paying taxes on this investment income until you take a withdrawal from the tax-deferred savings account or until you cash in the investment.

In other words, you can postpone taxes on any earnings you make on the money in your tax deferred accounts. That means your money is growing each year without having to remove any funds to pay tax.

Here are some numbers to chew on:

If you contributed $5,500 to a 401(k) plan each year from age 35-70 and averaged an eight percent annual rate of return, assuming a thirty-percent percent income-tax rate, at age 70, your 401(k) plan would be worth $1,023,562. In comparison, if you invested the funds personally, you would have just $716,493, a difference of a whopping $416,248.

One more thing to consider: if instead of making a pretax (traditional) 401(k) contribution, you made a Roth 401(k) plan contribution, and you waited until reaching the age of 59 1/2 and the Roth had been opened at least five years, all Roth 401(k) distributions would be tax free. Roth 401(k) plan contributions are not tax deductible, but for some, the ability to generate tax-free gains on all future account growth is very attractive than taking a current income tax deduction on the contribution amount.