What Is a Tax-Sheltered Annuity?

A tax-sheltered annuity allows an employee to make pretax contributions from his or her income into a retirement plan. Because the contributions are pretax, IRS does not tax the contributions and related benefits 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.

Understanding a 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 maximize contributions.

Comparing TSAs to 401(k) Plans

People often compare TSAs to 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 encourage individual savings by allowing for pretax contributions toward 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 with a 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 are qualified under Section 501(c)3 of the Internal Revenue Code can offer TSA plans to their employees.

Contribution Limits of TSAs

The IRS caps contributions to TSAs $19,500 for tax year 2020, which is the same cap as 401(k) plans. TSAs also offer a catch-up provision for participants over age 50, which totals $6,500 for tax year 2020. Tax shelter annuities 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. Including the contribution, catch-up provisions, and an employer match, the total contribution cannot exceed 100 percent of earnings up to a certain cap.


All qualified retirement plans require that withdrawals begin only after the age of 59 ½. Early withdrawals may be subject to a 10 percent IRS penalty unless certain exemptions apply. The IRS taxes withdrawals as ordinary income and requires them to start no later than the year the beneficiary turns 70 ½. Depending on the employer's or plan provider's provisions, employees may access funds before age 59 ½ via a loan. As with most qualified retirement plans, they may also permit withdrawals if the employee becomes disabled.