A special tax return is triggered if you give a gift and exceed the gift tax limit.
What is a tax-sheltered annuity?
A tax-sheltered annuity (TSA) is a retirement savings plan that allows employees of tax-exempt organizations and self-employed people to invest pretax dollars to build retirement income. Tax-sheltered annuities are designed to provide consistent payouts over time and act as a reliable source of income in retirement.
Annuities can be structured in a variety of ways. They can provide income for a specific time period (such as 25 years), guarantee payments for the annuitant’s entire life, and be structured to provide income to a surviving spouse if the annuity holder dies.
Like 401(k) plans, TSAs are tax-deferred instruments. However, TSA plans are restricted to employees of tax-exempt organizations and the self-employed, while 401(k) plans are open to any private-sector employee whose employer offers a plan.
Most 403(b) plans offer tax-sheltered annuities. Eligible participants include employees working for tax-exempt organizations and public schools. Nonprofit organizations that qualify under 501(c)3 of the IRS code may offer TSA plans to their employees.
The terms tax-sheltered annuity and 403(b) are often used interchangeably. When the 403(b) was created in 1958, it was known as a tax-sheltered annuity, as it only offered annuities. Over time, 403(b) plans have changed. While many 403(b) plans still offer tax-sheltered annuities, they now offer investments seen in 401(k) plans, including mutual funds.
With TSAs, employees’ contributions are deducted from their income and the investment grows without the burden of being taxed. Taxes are paid on the annuity once the employee starts to draw income from the investment.
TSA contribution limits are the same as 401(k) limits, and offer a catch-up provision for participants over 50 years old. Participants who have worked for a qualifying organization for 15 years or more and averaged a contribution limit of $5,000 or less are eligible for lifetime catch-up.
Use Bankrate’s annuity calculator to determine the investment amount needed to generate a specific payment.
Tax-sheltered annuity example
The chief advantage of a TSA is that it can help reduce your taxes. Suzy is a professor of rhetoric at a public university, with a $70,000 annual salary. She is deciding how much she will need to save monthly with only 15 years to go until her projected retirement age.
At retirement, Suzy expects to be making an annual income of about $100,000 a year, and would like to earn 75 percent of that amount once she has retired. Between Social Security, her university pension, and savings, she will generate nearly $60,000 a year, leaving her $15,000 short of her goal. Suzy’s advisor suggests a TSA.
To earn the $15,000 in additional annual income, Suzy’s advisor calculates a monthly contribution of about $700, for a total annuity of $210,000. Suzy authorizes her employer to make plan contributions of $700 a month from her salary, which will reduce her taxes by $230 or so for each pay period. With a TSA, Suzy is earning income with a net out-of-pocket cost of only $470.