What Is a Tax-Sheltered Annuity (TSA)?

A tax-sheltered annuity (TSA) is a type of investment vehicle that lets an employee make pretax contributions into a retirement account from income. Because the contributions are pretax, the Internal Revenue Service (IRS) does not tax the contributions and related benefits until the employee withdraws them from the plan.

Since the employer can also make direct contributions to the plan, the employee gains the benefit of having additional tax-free funds accruing.

Understanding Tax-Sheltered Annuities (TSAs)

The 403(b) plan is a tax-sheltered annuity in the U.S. 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.

The IRS caps contributions to TSAs at $22,500 for tax year 2023 (increasing to $23,000 for 2024), which is the same cap as 401(k) plans. TSAs also offer a catch-up provision for participants aged 50 or over, which totals $7,500 each year for 2023 and 2024.

Tax-sheltered 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% of earnings up to a certain cap.

All qualified retirement plans require that withdrawals begin only after the age of 59½. Early withdrawals may be subject to a 10% 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 72, up from 70½ after the enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019.

Tax-Sheltered Annuities (TSAs) vs. 401(k) Plans

People often compare TSAs to 401(k) plans. The biggest similarity is that both plans represent specific sections of the Internal Revenue Code (IRC) 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. Notably, 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 IRC can offer TSA plans to employees.

The Bottom Line

Saving for retirement shouldn't be difficult, especially when your employer offers a retirement plan. Take advantage of tax-sheltered annuities or 403(b) plans if you work at a church, non-profit, or public school if your employer has one available. You can reap the benefits of tax advantages, such as using pre-tax dollars for your contributions, and you may even be able to get free money in your account if your employer matches your contribution, giving you more bang for your buck.