[Company Logo Image]

IRS Enrolled Agent Logo

Tax Sheltered Annuity

Employees of a public school system or a tax-exempt employer qualifying under Section 501(c)(3) of the code may be eligible to receive special income tax reductions under an approved savings program using Tax Sheltered Annuities (sometimes called Tax Deferred Annuities).

You may defer a portion of your taxable income (within limits) by means of a salary reduction agreement with the employer, or you may direct your employer to apply a salary increase toward the purchase of a Tax Sheltered Annuity for the employee's benefit. There are three extremely valuable tax benefits under the provisions of the Tax Sheltered Annuity program:

NO CURRENT TAX ON INCOME

You do not pay current income tax on the portion of your earned income allocated to the annuity.

NO CURRENT TAX ON ACCUMULATED EARNINGS

All earnings on the funds accumulated in the account are exempt from income tax until benefits are received.

TAX DEFERRAL AFTER RETIREMENT

Even after retirement, all the funds still remaining within your TSA account will continue to enjoy tax-free earnings. You pay tax only on the amounts withdrawn, and you can postpone this until age 70 if desired.

AMPLIFIED INVESTMENT GROWTH

This tax favoritism allows a Tax Sheltered Annuity to grow at extremely attractive rates compared to personal savings, which must be funded with after-tax dollars, and on which earnings will be substantially reduced by taxes on all the earnings.

INVESTMENT OPTIONS

Funds must be placed in an annuity policy issued by a life insurance company, or in a mutual fund account which has certain administrative provisions for such employee benefit plans.

· Fixed Return Annuities

These contracts have a guaranteed rate of return, and the balance of the account is also guaranteed. The insurance company will issue a guaranteed rate for a period of time ranging from three months to six years. While they have the ability to raise or lower the rate, the value of your account is not subject to fluctuation.

· Variable Annuities

These contracts are similar to a mutual fund, but have an annuity-insurance wrapper that adds features and benefits. The insurance company offers life expectancy retirement options and will also provide that in the event of the policy owner's death, the benefit will be not less than the amount contributed.

Funds are directed by the account holder to one or more of the investment accounts offered by the insurance company. These are separate accounts, and not co-mingled with the general funds ofthe insurer. Therefore, they are not subject to risk based on the solvency of the company.

The sub-accounts are like mutual funds, and may be invested in common stocks, government bonds, corporate bonds, etc. Each account will have a stated investment philosophy and a prospectus will provide further information. Policy owners may switch funds from one fund to another, with minimal restrictions.

· Mutual Funds

Generally these are within a "family" of funds that gives the owner the opportunity to switch from one to another. The full detail on these accounts will be contained in the prospectus.

The mutual funds, like the equity accounts of the variable annuity, are subject to market fluctuation. There are no guarantees. However, the general performance of these funds and variable annuities have been substantially greater than the rate of inflation or the fixed rates.

Since the Tax Sheltered Annuity is a long-term retirement vehicle, investment in equity accounts is generally advisable for all except those who are extremely risk-averse.

TSA GUIDELINES

As a general rule, you may contribute up to 16% of your earnings through these reductions, but special formulas must be used to calculate your exact "exclusion allowance" permitted by the IRS.

Benefit payments are taxable only when received, usually after retirement when most people are in a lower tax bracket. Funds can also be withdrawn prior to formal retirement, but at that time they would be taxable as income.

The Tax Sheltered Annuity can provide a guaranteed retirement income that cannot be outlived. You may select options including income arrangements that provide for continuing income to your spouse or income plans designed to adjust with inflation.

The way in which federal income taxes are calculated has changed dramatically. The changes are significant and far reaching. Included in the revisions are a large number that affect tax-favored retirement plans, including Tax Sheltered Annuity( TSA) and Individual Retirement Accounts, which are treated in a similar fashion.

The new tax laws changed rules applicable to all types of individual and employer provided retirement plans, including Tax Sheltered Annuity plans.

Fortunately for the many public education and certain non-profit organization's employees eligible for tax sheltered annuity plans, the changes preserved TSAs as one of the most effective ways to save money for retirement financial security.

The new rules took effect at various times between January 1987 and 1989. Generally, they fall into two types:

Those limiting contributions
Those limiting withdrawals before retirement

REVISED LIMITS ON CONTRIBUTIONS

Prior to the 1986 Tax Reform Act, the maximum combined contribution an employee and employer could make to all retirement plans, including a TSA plan, was to up $30,000 per year. This all-plan limit remains and has been increased to $44,000 as of 2006.

The maximum before-tax salary reduction an employer may have is calculated in the same manner as before. However, there is now a new annual maximum of $15,000.

If you have 15 or more years of non-profit service profit, the maximum may be up to $20,000 per year, or an extra $5,000, until a total "make-up" reduction of $20,000 is reached. This feature gives you the opportunity to make contributions for prior years of service with a non-profit employer.

The maximum TSA contribution is also reduced by any contribution made by salary reduction to a government employer provided Deferred Compensation Plan under IRC Section 457 or any plan of cash or deferred arrangement under IRC Section 401(k).

EXCISE TAX ON EARLY DISTRIBUTIONS

Payments or withdrawals made from a TSA plan have already been taxable as ordinary income prior to the new tax law. The tax bracket could have been as high as 50%.

Starting with 1987, these withdrawals are still subject to ordinary income tax on payments from your TSA, but at much lower rates. However, with the much lower ordinary income tax rates, there will also be an additional federal income tax equal to 10% of your TSA payments unless:

You have reached age 59 1/2, or . . .
You have met the requirements under your employer retirement plan for early retirement upon separating from service at age 55 or older or..
You have elected to receive the value of your TSA in a series of substantially equal periodic payments for your lifetime (or lifetime of you and your spouse), or . . .
The payments are used to pay medical expenses in excess of 7 1/2% of adjusted gross income, or . . .
The payments are made after death or total disability, or . . .
Payments are made as result of a qualified TSA loan.

RESTRICTIONS ON DISTRIBUTIONS

To make the rules applicable to payments from a TSA plan similar to those applicable to other types of retirement plans, such as the popular 401(k) plans provided by corporate employers, new rules were imposed in 1989. These limit the events under which participants may receive elective deferrals, such as salary reduction amounts, from a TSA plan to:

Payments made following separation of service
Payments made following a death or total disability
Payments made as a result of financial hardship

The payments made under this provision will generally be limited to your contributions only and not the earnings or any contribution made directly by your employer.

Note that the restrictions on distributions that took effect in 1989, operate independently of distributions that were pre-1989.

DISTRIBUTIONS STARTING AGE 70 1/2 OR BEFORE

Under prior law you usually did not have to start to receive a TSA account until age 75 or even later. Under the new law, effective in 1989, you must begin receiving benefits by April 1 of the calendar year following the calendar year in which you attain age

70 1/2.

You must draw enough funds from your TSA each year so as to exhaust the funds over your lifetime or the joint lifetimes of you and your spouse. To the extent that insufficient funds are withdrawn, you could be subject to a 50% excise tax in the amount that should have been withdrawn.

LOANS FROM TSA PLANS

The new law provides for a maximum loan of 50% of your account balance up to $50,000, less any loan amount outstanding during the previous 12 months.

The loan must be repaid in five years. The repayment period maybe longer if the loan is used to acquire your principal residence. The new law requires that the loan be repaid on a level amortization of principal and interest over the period of the loan, with at least quarterly payments.

The interest payable will not be tax deductible. Residence rehabilitation loans and loans for residences of family members of participants are no longer permitted.

[Back] [Home] [Up] [Next]

Disclaimer
We do not offer legal advice. All information provided on this website is for informational purposes only and is not a substitute for proper legal advice. If you have legal questions, we recommend that you seek the advice of legal professionals.

Tax Disclaimer: To ensure compliance with IRS Rules, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.