Tax-Sheltered Annuity

What is a 'Tax-Sheltered Annuity'

A tax-sheltered annuity (TSA) allows an employee to make contributions from his income into a retirement plan. The contributions are deducted from the employee's income and, as a result, the contributions and related benefits are not taxed until the employee withdraws them from the plan. Because the employer can also make direct contributions to the plan, the employee gains the benefit of having additional tax-free funds accruing.

BREAKING DOWN 'Tax-Sheltered Annuity'

In the United States, one specific tax-sheltered annuity is the 403(b) plan. This plan provides employees of certain nonprofit and public education institutions with a tax-sheltered method of saving for retirement. There is usually a maximum amount that each employee can contribute to the plan, but sometimes there are catch-up provisions that allow employees to make additional contributions to make up for previous years when they did not make the maximum contribution.

Comparing TSAs to 401(k) Plans

TSAs are often compared with 401(k) plans. Their biggest similarity is that they both represent specific sections of the Internal Revenue Code that establish qualifications for their use and their tax benefits. Both plans were designed to encourage individual savings by allowing for pre-tax contributions towards accumulating retirement savings on a tax-deferred basis.

From there, the two plans diverge. 401(k) plans are available to any eligible private sector employee who works for a company that offers the plan. TSA plans are reserved for employees of tax-exempt organizations and public schools. Nonprofit organizations that exist for charitable, religious or educational purposes and that are qualified under Section 501(c)3 of the Internal Revenue Code are eligible to offer TSA plans to their employees.

Contribution Limits

Contributions to TSAs are capped at the same level as contributions made to 401(k) plans and include a catch-up provision for participants over age 50. TSAs also include a lifetime catch-up for participants who have worked for a qualified organization for 15 years or more and whose average contribution level never exceeded $5,000 over that period of time. Including the contribution, catch-up provisions and an employer match, the total contribution cannot exceed 100% of earnings up to a certain cap.


All qualified retirement plans require that withdrawals commence only after the age of 59 ½. Early withdrawals may be subject to a 10% IRS penalty unless certain exemptions apply. Withdrawals are taxed as ordinary income, and the IRS requires that they commence no later than the age of 70 ½. Depending on the employer's or plan provider's provisions, employees may be able to access funds prior to age 59 ½ via a loan. As with most qualified retirement plans, withdrawals may also be permitted if the employee becomes disabled.