What a Tax-Sheltered Annuity Is and How It Works

A tax-sheltered annuity lets you set aside money from your paycheck before taxes are taken out

A tax-sheltered annuity (TSA), also called a 403(b) plan, is a retirement savings account offered by schools, hospitals, nonprofits, and some government employers. You contribute money directly from your salary, and that money is not taxed in the year you earn it. Instead, you pay taxes on it later, when you withdraw it in retirement.

The main appeal is that you reduce your taxable income now. If you earn $50,000 and contribute $5,000 to a TSA, you only report $45,000 as taxable income that year. You still owe taxes on the $5,000 eventually, but deferring that tax bill lets your money grow without being nibbled away by annual tax payments.

TSAs work through insurance companies, not through a brokerage or bank. Your employer arranges the contract with the insurance company, and you choose how much to contribute each pay period. The money sits in an annuity — a contract that promises to pay you income later — and grows tax-deferred until you reach retirement age.

Key Takeaways

• A TSA is a retirement plan for employees of schools, nonprofits, hospitals, and certain government agencies, where contributions come straight from your paycheck before taxes.
• Your contributions reduce your taxable income in the year you make them, but you pay income tax on withdrawals in retirement.
• TSAs are offered through insurance companies, and your employer must sponsor the plan — you cannot open one on your own.
• You can contribute up to a set annual limit, which varies by year and may be higher if you have worked at your employer for 15 years or more.
• Withdrawals before age 59½ usually trigger a 10 percent penalty plus income tax, though some employers allow loans or hardship withdrawals.

How contributions and tax deferral work

When you enroll in your employer's TSA plan, you tell payroll what percentage or dollar amount to deduct from each paycheck. That money goes directly to the insurance company managing your account — it never hits your bank account. Because the contribution happens before your employer calculates income tax withholding, you owe less federal income tax that year.

The money sits in the annuity contract and grows over time. You do not pay tax on the growth — the interest, dividends, or investment gains — until you withdraw it. This is the tax deferral benefit. A regular savings account would require you to pay tax on interest each year, but a TSA lets that interest compound without annual tax drag.

You will receive a Form 5498-SA from the insurance company each year showing how much you contributed. This form helps you and the IRS track your contributions for tax purposes.

Contribution limits and catch-up rules

The IRS sets an annual contribution limit for TSAs. This limit changes year to year and is the same as the 401(k) limit. For 2024, the limit is $23,500, but you should check with your plan administrator or the IRS website for the current year's figure.

If you have worked at your employer for 15 or more years, you may be able to contribute an extra amount called a catch-up contribution. This allows older workers to save more as they approach retirement. The catch-up amount is separate from the standard limit, and not all plans offer it, so ask your benefits department whether yours does.

Some employers also match a portion of your contributions, similar to a 401(k). If your employer offers a match, that is information programs toward your retirement, so contributing enough to capture the full match is usually worthwhile.

How withdrawals and taxes work in retirement

Once you reach age 59½, you can withdraw money from your TSA without penalty. When you do, you owe federal income tax on the full amount withdrawn — both your contributions and all the growth. You will receive a Form 1099-R showing the withdrawal amount, and you report it as income on your tax return.

If you withdraw money before age 59½, you owe income tax plus a 10 percent early withdrawal penalty on the amount withdrawn. There are a few exceptions: if you leave your job and are age 55 or older, you may withdraw without the penalty. Some plans also allow loans or hardship withdrawals for specific situations like medical bills or home purchase, though these vary by plan.

The IRS requires you to begin taking withdrawals at age 73 (as of 2023). These are called required minimum distributions, or RMDs. The amount is calculated based on your age and account balance, and you must withdraw at least that amount each year or face a penalty.

TSA versus 401(k) and other retirement plans

A TSA is similar to a 401(k) in that both are employer-sponsored, both defer taxes on contributions, and both have the same annual contribution limits. The main differences are who can offer them and how they are invested. TSAs are only offered by schools, nonprofits, hospitals, and certain government employers. A 401(k) is offered by for-profit companies.

TSAs are invested through insurance companies in annuity contracts, while 401(k)s typically offer a menu of mutual funds and other investments chosen by the employer. This means TSA investment options are often more limited, but annuities provide a may provide income stream in retirement, which some people value.

If your employer offers both a TSA and a 403(b) plan, they are usually the same thing — the terms are used interchangeably. If your employer offers a 401(k) instead, that is a different plan type with similar tax benefits but different investment structure and rules.

Vesting and portability

Unlike some 401(k) plans, TSA contributions are always yours when ready — there is no vesting period. The money you contribute belongs to you from day one, even if you leave your job tomorrow. Any employer match, if offered, may have a vesting schedule, so check your plan documents to see when matched funds become yours.

If you leave your job, you can usually leave your TSA with the insurance company, roll it into an IRA, or roll it into a new employer's retirement plan if they accept rollovers. A rollover lets you move the money without triggering taxes or penalties, as long as you follow the IRS rules for the transfer. Your plan administrator or the insurance company can explain your options.

How to enroll and manage your account

Your employer's human resources or benefits department handles TSA enrollment. They will give you plan documents, a list of investment options offered through the insurance company, and an enrollment form. You choose how much to contribute and which investment option to select — often a mix of stock and bond funds, or a target-date fund that adjusts as you age.

After enrollment, you can usually log into an online portal to view your balance, see how your investments are performing, and change your contribution amount. You can increase or decrease contributions during open enrollment or when you have a may have access to life event, like a marriage or birth of a child.

If you have questions about your account, contact the insurance company directly — they manage the day-to-day administration. Your employer's benefits department can also help with enrollment questions or issues with payroll deductions.

Frequently Asked Questions

Can I withdraw money from my TSA before retirement?

You can withdraw before age 59½, but you will owe income tax plus a 10 percent penalty on the amount. Some plans allow loans or hardship withdrawals for specific reasons like medical bills, and if you leave your job at age 55 or older, you may withdraw without the penalty. Ask your plan administrator what options your plan offers.

What happens to my TSA if I change jobs?

Your money stays in the account and continues to grow tax-deferred. You can leave it there, roll it into an IRA, or roll it into your new employer's retirement plan if they accept rollovers. A rollover avoids taxes and penalties as long as the money moves directly from one plan to another.

Is a TSA the same as a 403(b)?

Yes, TSA and 403(b) are the same thing. The plan is named after the IRS tax code section that governs it, and both terms refer to the same retirement account offered by nonprofits, schools, and government employers.

Do I have to contribute to my employer's TSA?

No, contributing is optional. Your employer offers the plan, but you decide whether to participate and how much to contribute. However, if your employer offers a match, you may miss out on information programs if you do not contribute.

What is the difference between a TSA and a Roth IRA?

A TSA is employer-sponsored and reduces your taxes now, but you pay taxes on withdrawals later. A Roth IRA is individual, you contribute after-tax money, and withdrawals in retirement are tax-free. You can have both — a TSA through work and a Roth IRA on your own.