28 May 2026 Tax Deferral, Liquidity, and Fundamental Laws

The United States income tax system is known as a “progressive” system, meaning that as your income goes up, your marginal tax rate goes up, to a point. This has been the case for a long time. The brackets and the top rates have moved around, but you know, it has generally been the case that those with more income pay more income taxes on a marginal and absolute basis.  

No one likes to pay taxes! And also people love for other people to pay more taxes. It’s all very emotional, and as the adage goes, certain. Anyway, your choices to pay less in taxes are essentially: Increase deductions, qualify for some sort of tax credit, make less money, and possibly, defer some of it. As Matt Levine likes to say, “The first fundamental law of tax is that it’s always better to have more money than less money,” so that penultimate option is pretty much a dud: all else being equal, intentionally making a dollar less of income to save half a dollar of taxes is not something a rational actor would do.  

The last one is more interesting. You can defer taxes. The tax code has a number of ways—ranging from extremely simple to catastrophically complex—not to avoid taxes, but to play a fun game of “when.” This game revolves around the difference between your marginal tax bracket today vs. some day in the future, and as such involves a good deal of guessing. From pre-tax IRAs (and other retirement accounts) to installment sales of a business to charitable remainder trusts to opportunity zone funds to like-kind exchanges to some truly insane things that I won’t bother trying to describe here, there are myriad ways to defer taxes.  

Now, it is common for folks in higher income tax brackets to want to defer as much taxes as they can. They assume that later on they will be in a lower bracket, pay tax then, and thus pay less taxes over their lifetime. And often that is true!

All that said, deferral is never free. Even the low-hanging fruit of deferral comes at a cost (sometimes worth paying) of liquidity. There are stringent rules about when you can actually start using the money socked away in your 401(k), and as you climb the ladder of deferral complexity, the liquidity constraints (among other flavors of constraint) are very real. For example, you can dump the gains from the sale of a piece of real property into the purchase of a new piece of real property, but if you want the equity in that real property to turn into liquid cash, you’re going to have to pay taxes and transaction costs first. Some deferrals have minimum lock-up times, significant up-front costs, or just the unnecessary risk of trying to get too cute with the tax law, but they all reduce liquidity. 

This word, liquidity, is not always helpful. When I read “liquidity,” what I see in my mind’s eye is “agency” or “optionality” or “I could spend this asset tomorrow if I wanted to or needed to.” I would say that this sense of not being constrained is easily the most underrated concept in personal finance, especially by those selling some of the more complex deferral strategies. Not all balance sheets are created equal, and being nimble where you can is worth something, sometimes even at the expense of tax deferral.

Enough of the philosophical takes. Practically, here are two things I think about when it comes to liquidity: 1) If cash flow allows, begin saving and investing in a brokerage account, and 2) Have some cash on hand. You can overdo the second one of course, like anything, but cash is the linchpin of liquidity. You can use it for emergencies or big planned expenses and not have to worry about selling a growing asset to do so.

What about brokerage accounts (sometimes referred to as “taxable accounts”)? These accounts are like a checking account for investments. You get taxed on dividends and interest as they are paid, but capital gains are deferred until you sell something. Best of all, no federal or state government is telling you when you can use that money. You can just…decide yourself. 

Here are some other cool things about the brokerage account: 

• You can give charitable gifts of appreciated stock, and the capital gain associated with the gifted stock just goes away forever. If you do this aggressively (and some of our clients have!) and take the added step of “backfilling” your brokerage account with cash you use to repurchase the gifted shares, then you can largely reduce the unrealized gains in your account. In this way, your brokerage account starts to act more and more like a Roth account (with some taxable dividends and interest). 
• You can borrow off of assets in brokerage accounts. This can be an effective way to create a bridge loan between selling and buying a home, for example. Use the assets in the brokerage account as collateral to make a down payment on the new house, then take the proceeds from the old house to pay down debt later when that transaction closes. 
• You can harvest tax losses to offset some ordinary income and capital gains. These losses carry forward indefinitely. 
• If you get to the end of your life not having needed to use the liquidity a brokerage account represents, you can leave it to heirs, and any unrealized gains just go away as of your death (this is the “step up in basis”). That is not so much a cool thing for you, as you would have expired in this example, but it is something that would be helpful to your heirs. 

To summarize, tax deferral is fine and can make a lot of sense. But be careful not to think of it as something to be pursued at all costs, especially the cost of liquidity!