Tax-Sheltered Annuity

What is Tax-Sheltered Annuity?

Tax-Sheltered Annuity (TSA) is a form of retirement savings plan in which the contributions made are from the income that has not been taxed and therefore the contributions and interest accrued on the same are not taxed during the period of savings while only the withdrawals are taxed.

Explanation

Tax-Sheltered Annuity

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How does Tax-Sheltered Annuity Work?

The setting up of the 403(b) plan is in the hands of the employer, and employees can’t set it up on their own.

  • Eligible beneficiaries include government school or college employees, church employees, and the employees of charitable organizations covered under Section 501(c)(3) of the IRC.
  • Employees and employers can contribute to the account.
  • Withdrawal before the allowable date attracts a 10% penalty.
  • The annual contribution was limited to USD 19,000 in 2019 and has been increased to USD 19,500 for the year 2020.
  • There is a provision to make additional contributions for the years in which the contribution was lower than the upper limit.
  • The total contribution is limited to USD 57,000 for 2020, which was USD 56,000 in 2019; this includes the employer and employee contribution.
  • If an employee has more than one retirement savings plan, then the combined annual total contribution should be as per the prescribed limit of USD 19,500 for 2020.

Tax-Sheltered Annuity Plan

Under the tax-sheltered annuity 403(b) plan, there are various methods of making contributions, based on which the following terminology has been defined:

Withdrawal of Tax-Sheltered Annuity

Distribution of the accumulated funds can be made at the occurrence of the following events:

  • Once the employee reaches the age of 59 years and 6 months.
  • Has been untimely severed from his employment;
  • Death of the employee, in this case, his legal heirs, receives the payment.
  • Physical or mental disability.
  • If the contribution had been made under the effective deferral program, then the described financial hardship allows distribution.

These withdrawals are taxable entirely under the ordinary incomeOrdinary IncomeOrdinary income refers to an individual's or business entity's earnings that are taxable at the regular rates. Such earnings include salary, wages, rent received, royalty, commission, interest received, profit, etc. It excludes all incomes with tax deducted at source and capital gain.read more head except if the payments were made to the Roth account.

  • A minimum limit amount of interest, if not the entire amount, accrued post-1986, should be withdrawn by April 1st of the year in which the employee reaches the age of 70 years and 6 months or when he retires, whichever falls on a later date. The interest amount can be transferred to another employee under contract exchange provision, and this transfer is tax-free. However, several conditions need to be met for such a transfer post-September 24, 2007.
  • Instead of withdrawing, at the end of the TSA, accumulated funds can be rolled over to a Roth IRA as per the specified rules. Such rollover gets taxed in that year.

Advantages

Disadvantages

  • At times the tax slab revision might be detrimental, and uncertainty regarding the same becomes a problem because, at the time of withdrawal, the tax rates might be higher than when the contribution was made.
  • Premature withdrawal attracts penalty as per the describe rules of the account. Therefore the process of gathering proof that such a penalty doesn’t apply in certain cases becomes tedious and causes stress when there is an urgent need of funds.
  • There are caps on the maximum amount that can be contributed in such an account, and the excess amount gets taxed.
  • Further, calculating the maximum contribution based upon the given income, if it is below the maximum allowable limit, requires in-depth knowledge of tax law and therefore requires hiring a tax consultant, which can be time-consuming and costly.

Conclusion

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