What Is a Tax-Sheltered Annuity?
A tax-sheltered annuity is a form of investment instrument that allows employees to make pretax contributions to a retirement account from their earnings. The Internal Revenue Service (IRS) does not tax the contributions and associated benefits until the employee withdraws them from the plan since they are pretax.
Because the employer may also make direct contributions to the plan, the employee benefits from the accrual of extra tax-free cash.
- Employees may invest money before taxes in a retirement plan using a tax-sheltered annuity.
- Employees of public schools and tax-exempt organizations are eligible for TSA plans.
- The IRS taxes withdrawals but not donations to tax-sheltered annuities.
- Employees benefit from greater tax-free cash accumulating because employers may contribute to TSA programs.
- Charities, religious groups, and other charities may be eligible to provide tax-sheltered annuities to their workers.
Understanding a Tax-Sheltered Annuity
The 403(b) plan is one kind of tax-sheltered annuity in the United States. This plan offers workers of some nonprofit and public education organizations a tax-advantaged way to save for retirement. There is normally a cap on how much each employee may contribute to the plan, but there are often catch-up provisions that enable workers to make more contributions to make up for earlier years when they did not maximize contributions.
TSA contributions are capped at $19,500 for tax year 2021 (rising to $20,500 for 2022), the same as 401(k) contributions. TSAs additionally include a catch-up provision for participants aged 50 and older, totaling $6,500 for tax year 2021 (and $6,500 for tax year 2022).
Participants in tax-sheltered annuities are also eligible for a lifetime catch-up if they have worked for a qualifying organization for 15 years or more and their average contribution amount has never surpassed $5,000 throughout that time. The overall contribution, including the contribution, catch-up provisions, and an employer match, cannot exceed 100% of earnings up to a specific limit.
Withdrawals from all qualifying retirement plans must commence after the age of 5912. Unless specific exemptions apply, early withdrawals may be subject to a 10% IRS penalty. The IRS taxes withdrawals as regular income and requires them to begin no later than the beneficiary’s 72nd birthday, an increase from 7012 after the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019. Employees may borrow money before reaching the age of 5912, depending on the conditions of their company or plan provider. They may also allow withdrawals if the employee becomes incapacitated, as with most eligible retirement plans.
TSAs vs. 401(k) Plans
TSAs are often compared to 401(k) plans. The most striking resemblance is that both plans embody particular portions of the Internal Revenue Code that define eligibility and tax advantages. Both schemes promote individual savings by permitting pretax contributions toward tax-deferred retirement savings accumulation.
The two plans differ from there. 401(k) plans, in particular, are accessible to every qualifying private sector employee who works for a business that offers one. Employees of tax-exempt organizations and public schools are eligible for TSA plans. Employees may be offered TSA plans by nonprofit organizations that operate for charitable, religious, or educational reasons and are eligible under Section 501(c)(3) of the Internal Revenue Code.
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