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What Is a Tax-Sheltered Annuity?

A tax-sheltered annuity is a retirement plan offered by tax-exempt employers.

Written by Jacqueline DeMarco / July 1, 2022

Quick Bites

  • Tax-sheltered annuities work similar to 401(k) plans but only certain types of employers can offer them.
  • A tax-sheltered annuity is also known as a 403(b) plan or a TSA plan.
  • Employers can make contributions to their employees’ tax-sheltered annuities.

A tax-sheltered annuity is a retirement plan offered by tax-exempt employers like a veterans and child care organizations. The tax-sheltered bit means that you make pretax contributions into your account, ie, the Internal Revenue Service (IRS) won’t tax said contributions until you withdraw the funds.

Keep reading for more insight into how tax-sheltered annuities work.

Inside this article

  1. What's an annuity?
  2. What is a tax-sheltered annuity?
  3. TSA vs 401(k)
  4. TSA payroll deductions
  5. TSA withdrawal rules
  6. FAQ

What's an annuity?

An annuity is an insurance product that pays out a fixed stream of payments to an individual, typically over a period of more than one year, says Michael Ryan, financial coach and planner.

“Annuities can be used for a variety of purposes, including retirement planning, estate planning, and tax-advantaged investing,” Ryan says. Annuities are generally available to all.

“An annuity can be a valuable tool in retirement planning, providing a guaranteed stream of income for life,” Ryan says. “This can be a critical asset for retirees, who may be living on a fixed income and need to know that their income will not fluctuate.”

Illustration of Michael Ryan

Meet the Expert

Michael Ryan, financial coach and planner, and founder of MichaelRyanMoney.com.


What is a tax-sheltered annuity?

A tax-sheltered annuity—also known as a 403(b) plan or a TSA plan—is a type of retirement plan only offered by certain 501(c)(3) tax-exempt organizations such as charities or churches and public schools. Through a TSA, employees and their employers can contribute to their individual accounts.[1]

The contributions usually aren’t subject to state or federal income tax until distributions are made.

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On the downside, the employer chooses the investment options for the accounts and this type of plan can have high administrative costs. There are also contribution limits in place and if you make withdrawals before the age of 59 ½ you may face a 10% penalty fee.

TSA vs 401(k)

TSA plans and 401(k)s work similarly. Both are offered by employers and employers can make contributions to their employees’ plans. The main difference between these two types of accounts is who offers them. While a TSA plan is offered by select government, nonprofit and religious organizations, a 401(k) plan is provided to employees by for-profit companies.

One major difference worth noting is that with a TSA plan employees who have completed 15 years or more of service with the same nonprofit or government agency are allowed to contribute an additional $3,000 a year to their account (up to a $15,000 lifetime limit).

It’s also notable that TSA plans are administered by insurance companies and 401(k) plans are usually administered by mutual fund companies.[2]

TSA payroll deductions

You can deduct your TSA contributions directly from your paycheck which can make it easier to stay disciplined and contribute to your retirement savings consistently. There is an annual contribution limit and for the year 2022 the limit is $20,500 if you are under the age of 50, but if you are age 50 or older you can contribute an additional $6,500 (for a total of $27,000).

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TSA withdrawal rules

There are rules surrounding when you can withdraw the savings and earnings from your TSA plan. If you don’t want to pay a penalty, you have to wait until you are 59 ½ or older to start making withdrawals. If you make a withdrawal before that point, you’ll need to pay a 10% penalty unless a qualifying life event like becoming disabled excludes you from this penalty.

There is a limit surrounding how long you can wait to make withdrawals as well. You have to start taking the required minimum distribution by the time you turn 72.

FAQ

Who is eligible for a TSA plan?

You can only participate in a TSA plan if your employer offers it. Only certain employers, such as tax-exempt 501(c)(3) organizations, public schools, and cooperative hospital service organizations can offer TSA plans.

What is the difference between a TSA plan and a 403(b) plan?

A TSA plan and a 403(b) plan are the same thing, people just call them a few different names. You may also hear a TSA plan referred to as a tax-sheltered annuity.

How do you contribute to a TSA plan?

You can sign up to have your contributions automatically deducted from each paycheck, which can make staying on track towards saving for a retirement a lot easier. Your employer will also have the option of contributing to your TSA plan.

Article Sources
  1. “IRC 403(b) Tax-Sheltered Annuity Plans.” IRS. Feb. 18, 2022. https://www.irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans#:~:text=A%20403(b)%20plan%20
  2. “403(b) Plan.” Annuity.org. May 20, 2022. https://www.annuity.org/retirement/403b/

About the Author

Jacqueline DeMarco

Jacqueline DeMarco

Jacqueline has worked with more than two dozen financial brands, including LendingTree, Capital One, Bankrate, Student Loan Hero, and Northwestern Mutual, providing thoughtful content to give readers insight into complex topics that they likely didn’t learn in school.

Full bio

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