Alternative Retirement Savings Plan: Tax Sheltered Annuity 403(b)

Tax-Sheltered Annuity (TSA), also known as a 403(b), is an alternative retirement savings plan. Not everyone can participate in this plan, and it is restricted to those who are employed by educational, cultural, or non-profit organizations such as religious groups (also known as 501 (c)(3) organizations).


Contributions to a Tax-Sheltered Annuity are done through a payroll deduction and are therefore taken out pre-tax. This feature of a Tax-Sheltered Annuity is very beneficial since your contributions are not seen as income and you may pay less federal tax at the end of the year. A Tax-Sheltered Annuity is also tax deferred during the accumulation phase. This means you will not pay any taxes on the amount you contribute or the interest earned until you begin the withdrawal phase.

If your plan allows, you may elect to contribute post-tax money to your Tax-Sheltered Annuity by using your paycheck. Any money you contribute post-tax must be declared on your income tax return and is not subject to the tax-deferred exemption. When selecting a Tax-Sheltered Annuity you may choose between fixed and variable, or a combination of the two.

It is possible to take loans from your Tax-Sheltered Annuity, but these loans are limited to the lesser of $50,000 or fifty percent of your vested amount. Another feature of a Tax-Sheltered Annuity is the ability to rollover funds into other investment options. For example, it is possible to use your 403(b) to fund your 401(k), Individual Retirement Account (IRA), or another 403(b).

It is important to check any contribution limits or rules established by the new plan administrator before committing to a rollover. If you die before receiving payments, your beneficiaries are entitled to similar options using your Tax-Sheltered Annuity. A spouse is entitled to all of the aforementioned options, while a non-spouse is prohibited from using your annuity money to fund an IRA. A non-spouse beneficiary is only able to transfer funds from one 403(b) to another.


Unlike a regular deferred annuity, there are maximum contribution limits determined by the Internal Revenue Service (IRS) for each year. Beginning in 2006 the maximum personal (elective) contribution limit was increased to $15,000 per year, up from $14,000 in 2005. Also in 2006, your employer (non-elective) may choose to contribute to your Tax-Sheltered Annuity with a combined maximum contribution limit of $ 44,000.

You may be able to contribute up to $5000 more per year if you are age 50 or older and an additional $3000 per year if you have been with the same company for more than fifteen years. Failure to comply with these contribution limits can result in additional taxes and penalties for both the employee and contributing employer.


As with the deferred annuity, a Tax-Sheltered Annuity is used to supplement retirement income. If you decide to withdraw money prior to age 59 ½ you will be subject to a ten percent penalty by the IRS in addition to the standard income tax. There are a few exceptions to paying this penalty, although specific criteria must be met.

If you leave the service, encounter extreme and immediate financial hardship, or become disabled you can avoid paying the ten percent penalty. Although the ten percent penalty is not enforced in these cases, you are still responsible for paying income tax on the money you withdraw. You must begin taking minimum payments from your Tax-Sheltered Annuity in either the same year as your retire or by age 70 ½, whichever comes first.

Failure to do so will result in a fifty percent excise tax on the money you should be receiving. The only exception to this age restriction pertains to all contributions made to a Tax-Sheltered Annuity prior to January 1, 1987. Anyone who paid into a Tax-Sheltered Annuity before this date is allowed to defer withdrawal until age 75. If you die before the withdrawal period your beneficiaries may receive payouts from your Tax-Sheltered Annuity without paying the ten percent penalty, but they are still responsible for the income taxes.

Regulations on tax compliance change every few years to accommodate inflation rates, and it is important to familiarize yourself with these changes to avoid penalties from the IRS. Helpful resources including articles, worksheets, and an updated FAQ page can be located at and search for keywords “tax sheltered annuity.”