Harnessing the Power of Tax Deferral

As a financial professional working with public sector employees, your role is crucial in helping them understand the mechanics and long-term benefits of participating in their employer-sponsored retirement plan. Two foundational concepts that often need clarity are salary reduction and tax deferral. A well-explained approach can make the difference between passive enrollment and informed, confident participation.

Clarifying Salary Reduction

Start by explaining that salary reduction is the process by which employees elect to have a portion of their wages redirected into a retirement plan—such as a 403(b) or 457(b)—before income taxes are calculated. This reduces their taxable income in the current year while allowing that deferred portion to be invested.

It’s helpful to ground this explanation in real numbers. For instance, if an employee earning $50,000 chooses to contribute $5,000 to a retirement plan through salary reduction, they are only taxed on $45,000 of income that year. This illustrates both the immediate benefit of lower taxable income and the shift in focus from current consumption to future financial security.

Communicating the Value of Tax Deferral

Tax deferral refers to the ability to invest retirement contributions without paying taxes annually on interest, dividends, or capital gains. Unlike a regular savings account or taxable brokerage, the investments in these plans grow uninterrupted by annual tax liabilities.

Emphasize that this allows more of the employee’s money to remain invested over time, which significantly enhances compounding. Taxes are eventually paid when funds are withdrawn, typically in retirement. For many employees, this may be at a time when their income—and therefore their tax bracket—is lower.

Demonstrating Long-Term Impact Through a Basic Projection

Using a simplified example can help make this concept concrete. Suppose an employee contributes $5,000 annually to their retirement plan and earns a consistent 7% return. Over 10 years, their account could grow to approximately $69,000. If they continue for 20 years, the account might reach over $219,000. At 30 years, the balance could exceed $500,000—all without paying taxes on the growth during those years.

This illustration doesn’t just highlight the potential dollar amount; it underscores the exponential impact of tax-deferred compounding over time. Employees who grasp this often gain a clearer understanding of the long-term value of even modest annual contributions.

Helping Employees Appreciate the Role of Time

Even modest contributions can grow substantially over time due to compounding. For instance, $5,000 contributed annually at a 7% return could grow to over $500,000 in 30 years—all without annual taxes reducing investment gains. The earlier employees start, the greater the benefit. Conversely, delays in participation can dramatically reduce future outcomes, even if contribution levels increase later in their careers.

This can be a compelling way to shift the mindset from “Can I afford to contribute?” to “Can I afford not to start now?”

Framing the Conversation

Employees often hesitate to reduce their take-home pay. Position salary reduction as a shift—not a loss—of income: from today’s spending to tomorrow’s security. Focus on the dual benefit of lower taxes now and greater potential income in retirement. Clear, straightforward conversations build trust and support long-term participation.

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The companies of National Life Group and their representatives do not offer tax or legal advice. For advice concerning your own situation, please consult with your appropriate professional advisor.