A tax-sheltered annuity is a retirement savings account for certain nonprofit and public employees

A tax-sheltered annuity (TSA), also called a 403(b) plan, lets you set aside money from your paycheck before taxes are taken out. The money grows without being taxed each year, and you do not pay taxes on it until you withdraw it in retirement. It is offered by schools, hospitals, nonprofits, and some government agencies — not by private employers.

The main appeal is that you reduce your taxable income now and let your savings compound over decades. If you earn $50,000 and contribute $5,000 to a TSA, you only pay income tax on $45,000 that year. The $5,000 and all its growth sit untouched until you reach age 59½ or leave your job.

TSAs are similar to 401(k) plans that private companies offer, but they have different rules and are designed for the nonprofit and public sectors. Understanding how they work helps you decide whether to use one and how much to contribute.

Key Takeaways

  • A TSA reduces your current taxable income because contributions come out before taxes, lowering what you owe the IRS that year.
  • Your money grows tax-free inside the account, meaning you do not pay taxes on investment gains until you withdraw the money.
  • You can contribute up to $23,500 per year (as of 2024), with a catch-up amount of $7,500 more if you are 50 or older.
  • Withdrawals before age 59½ usually trigger a 10 percent penalty plus income tax, unless you leave your job or meet other exceptions.
  • Your employer does not have to match your contributions, though some nonprofits and schools do offer matching funds.

How contributions and tax deferral work

When you enroll in a TSA, you choose a percentage or dollar amount to contribute from each paycheck. Your employer sends that money directly to the TSA provider — usually an insurance company or investment firm — before your paycheck is taxed. This is called a pre-tax contribution.

If you contribute $300 per paycheck and your employer withholds $200 in federal income tax, the $300 comes out first. You only pay income tax on the remaining amount. Over a year, this can save you hundreds or thousands in taxes, depending on your tax bracket and how much you contribute.

The money inside the TSA is invested — typically in mutual funds, annuities, or stable value funds. Whatever gains it earns (interest, dividends, capital appreciation) are not taxed that year. If your $10,000 grows to $12,000, you do not report that $2,000 gain on your tax return. The tax bill comes later, when you withdraw the money in retirement.

Contribution limits and catch-up rules

The IRS sets an annual limit on how much you can contribute to a TSA. For 2024, the limit is $23,500 per year. If you are 50 or older, you can contribute an additional $7,500 per year, bringing your total to $31,000. These limits change slightly each year to keep pace with inflation.

Some TSA plans also allow a special catch-up provision if you have worked at your employer for 15 years or more. This can let you contribute an extra $3,000 per year (up to a lifetime total of $15,000 extra) if you did not max out your contributions in earlier years. Ask your plan administrator whether your plan offers this option.

Your employer may also contribute to your TSA, though they are not required to. Some schools and nonprofits match a portion of your contributions, similar to a 401(k) match. Any employer contribution counts toward your annual limit.

When you can withdraw money and what happens if you withdraw early

You can withdraw money from your TSA without penalty once you reach age 59½, retire, or leave your job. If you withdraw before age 59½ and are still employed, you typically owe a 10 percent early withdrawal penalty plus income tax on the amount you take out.

There are narrow exceptions to the early withdrawal penalty. You can withdraw without penalty if you become disabled, face a financial hardship that your plan recognizes, or take a loan from the plan (if your plan allows loans). Hardship withdrawals are limited and require documentation — your plan administrator can explain what qualifies.

Once you leave your job, you have more flexibility. You can leave the money in the TSA, roll it into an IRA or another employer plan, or withdraw it. If you withdraw, you owe income tax on the full amount, but the 10 percent penalty does not explore if you are no longer employed by that organization.

TSA versus 401(k) and IRA accounts

A TSA works much like a 401(k), but TSAs are only available through nonprofits and public employers. Both let you contribute pre-tax money, both grow tax-deferred, and both have the same annual contribution limits. The main differences are in the investment options and rules: TSAs often offer annuities (insurance products that may provide income), while 401(k)s typically offer mutual funds.

An IRA (Individual Retirement Account) is something you open on your own, not through an employer. IRAs have lower annual contribution limits ($7,000 in 2024, or $8,000 if you are 50 or older) but more flexibility in how you invest the money. If you have access to a TSA through your job, you can also open an IRA and contribute to both in the same year, as long as you stay within the separate limits for each.

If you leave a nonprofit job and move to a private employer, you cannot contribute to a TSA anymore. You can roll your TSA balance into an IRA or your new employer's 401(k) to keep the tax-deferred growth going.

How to enroll and choose your investments

Your employer's human resources or payroll department handles TSA enrollment. They will give you a list of approved TSA providers and investment options. You choose a provider and decide how to invest your contributions — for example, how much goes into stock funds, bond funds, or annuities.

Take time to understand the investment options before you enroll. Some TSAs offer annuities, which are insurance contracts that pay you a may provide income in retirement; others offer mutual funds, which rise and fall with the market. Your choice affects how much money you will have and how stable your retirement income will be.

You can change your investment choices and your contribution amount once per year, or more often if your plan allows. If you switch jobs within the nonprofit sector, you may be able to roll your TSA balance to your new employer's plan or keep it with your old provider.

Required minimum distributions and taxes in retirement

Once you reach age 73, the IRS requires you to start taking money out of your TSA each year — these are called required minimum distributions (RMDs). The amount is based on your age and account balance. You must report these withdrawals as income on your tax return and pay income tax on them.

If you do not take your RMD, the IRS charges a penalty of 25 percent of the amount you should have withdrawn (reduced to 10 percent if you correct it within two years). This is a steep penalty, so mark your calendar and plan ahead with your TSA provider.

When you withdraw money in retirement, you pay income tax at your current tax rate. If you are in a lower tax bracket in retirement than you were while working, you may pay less tax overall — which is the main advantage of deferring taxes now. However, if your retirement income is high, you may owe the same or more tax than you would have paid upfront.

Frequently Asked Questions

Can I have a TSA if I work for a private company?

No. TSAs are only available through schools, hospitals, nonprofits, and some government agencies. If you work for a private employer, your company may offer a 401(k) instead. You can always open an IRA on your own, regardless of where you work.

What happens to my TSA if I leave my job?

Your money stays in the account and continues to grow tax-free. You can leave it there, roll it into an IRA or your new employer's plan, or withdraw it (though you will owe income tax and possibly a 10 percent penalty if you are under 59½). Contact your TSA provider to discuss your options before you leave.

Do I have to contribute to a TSA if my employer offers one?

No. Contributing to a TSA is voluntary. However, if your employer matches contributions, you may want to contribute at least enough to capture the full match — that is information programs toward your retirement.

Can I borrow from my TSA?

Some TSA plans allow loans, but not all. If your plan does, you typically can borrow up to 50 percent of your balance (up to $50,000) and repay it over five years. Ask your plan administrator whether loans are available and what the terms are.

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

A traditional TSA reduces your taxes now (pre-tax contributions), and you pay taxes when you withdraw. A Roth TSA uses after-tax contributions, so you do not get a tax break now, but withdrawals in retirement are tax-free. Some employers offer both options; you choose which fits your situation better.