I'm not sure I understand the concept of "tax-free inside buildup."

From what I understand, life insurance, annuities and IRAs (both Traditional IRAs & Roth IRAs) benefit from "tax-free inside buildup." This essentially means that they are invested on a tax-free basis. But isn't it true that certain contributions to these devices are non-deductible?

I'm not sure what the term is intended to convey. If an example can be provided that would also be helpful.


The term is intended to convey that there aren't annual tax bills for having that investment option. Generally, investment choices may be tax-deferred like Traditional IRAs where once the monies are removed then they are taxes or tax-free like Roth IRAs where the money is withdrawn without having to pay any taxes.

Imagine you own $10,000 worth of shares in a mutual fund that pays out 3% each year in dividends and has zero capital gains. There are $300 each year coming out that can be re-invested but if the shares are held in a taxable account then there are taxes to be paid on the distributions. If the shares are held in an IRA, then there isn't that tax bill each year.


Think of it as a "tax shelter." The term indicates that investment earnings are not taxed while the assets remain within the account.

Practical examples:

Account a.) $10,000 is put into a regular investment account.

Account b.) $10,000 is put into a tax-sheltered 401(k) account.

In account a, dividends and capital gains are subject to taxation. If account a invests in VFIFX and earns 20%, when the assets are sold, it will be taxed as capital gains. 85% (assuming 15% capital gains tax) of 20% is a 17% gain.

In account b, the investment earning are not subject to taxation. If account b invests in VFIFX and earns 20%, the assets can be sold with no taxation for a 20% gain.

While the math above isn't exact, it illustrates the principle.

  • Does this mean that when Account B is taxed, the tax will be levied on the $10K investment. But in Account A, the tax will be levied on the investment PLUS the earnings (whether through interest or dividends) of the account? – user20687 May 4 '15 at 20:41
  • @franklin The tax is only levied on gains under the doctrine of constructive receipt. The $10k would have already been taxed before making its way into the investment account. – oBreak May 8 '15 at 19:19

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