Tax Sheltered Annuity

A tax sheltered annuity, or TSA, is a long term retirement plan that provides a systematic, tax sheltered way to accumulate funds for retirement. If someone works for a school or other qualifying teahouse organization covered under IRC Section 501(c) (3), they can accumulate money for your retirement in a special tax sheltered plan known as a 403(b). A TSA reduces a person’s current taxable income. The contributions from a TSA are excluded from a person’s current taxable income and the interest earned or capital gains credited to the account are tax deferred until the owner begins to receive distributions from the TSA. The IRS has created a formula known as the Maximum Exclusion Allowance that governs the maximum contribution that an owner can make to a TSA in a given year.

A TSA offers a high degree of financial security. TSA’s are commonly offered in the form of fixed annuities or equity index annuities. These types of TSA’s are guaranteed to earn no less than a guaranteed minimum interest rate stated in the annuity contract. The fixed annuities are backed by the general account of the insurance company. Also, having a TSA does not reduce other retirement benefits. A person can receive TSA benefits in addition to a person’s pension benefits. Social Security credits are not affected because they are determined by a person’s gross earnings prior to TSA contributions.

A TSA will reduce a person’s income taxes. For example in this illustration if someone earning $40,000 a year and out $4,800 into a TSA, they would pay taxes on only $35,000. At a 28% tax rate, that means you would pay $1,344 less in income taxes. If they add their income tax savings to their regular TSA contributions, they would have even more money in their TSA and they would reduce their taxable income again. At a 28% tax rate, that would let you set aside $555.56 a month with the same take home pay as you'd have saving $400 a month with a taxable account. For example, over 10 years, the TSA advantage over a taxable account would come to almost $31,000, assuming a 6.0% interest rate for both, and no withdrawals. Over 20 years, the advantage would be more than $101,000. It's clear, a TSA lets someone set aside more for retirement.

Generally the maximum annual contribution that someone may deduct from their salary is the lesser of sixteen and two thirds of their gross income not to exceed $9,500. Effective January 1, 1998, the cap of $9,500 has been increased by the IRS to $10,000. This amount is also known as the Maximum Exclusion Allowance. This formula takes into account a person’s salary, the number of years they have been employed, and prior to contributions to TSA’s and other qualified plans. In addition to the Maximum Exclusion Allowance calculation, there is also a “Catch-Up Provision”. This provision is available a person if they have been employed by the same employer for fifteen years or longer and the maximum contribution under this $13,000. If there is a reason that someone stops contributing to their TSA account, the money in the account will continue to earn tax deferred interest. Neither the surrender charges nor the interest rate on the policy will be affected. A person can then resume contributions at a later date. Beneficiaries will receive the account value of a TSA, penalty free, minus the balance of any outstanding loans. This distribution generally does not have to go through probate and is subject to income tax. The owner or the beneficiary may specify how benefits are distributed in a lumps sum payment, monthly or annual payments or a combination, within IRS limits.

If a person changes employers, they have the following options:

• Continue the plan with their new employer if the new employer is eligible and willing to do so. (If this is done, all restrictions and rules concerning TSA distributions will continue to apply.)
• Leave their TSA contributions in their policy to continue accumulating tax-deferred interest until retirement.
• Start receiving annuity payments from their TSA
• Withdraw the value of their TSA.

A TSA can benefit to a person even it they are retiring in a few years. If someone has a savings available for current living expenses, they may wish to divert a large part of their salary for this short period to take advantage of a TSA’s substantially tax benefits. This is an individual decision, however, upon that they should seek competent tax advice.