Is a Tax Sheltered Annuity Qualified?

Posted by David Funes on Mar 18, 2021


Shelters, annuities, qualified, unqualified…all of these terms can get confusing when an investor planning for retirement is trying to figure out the best vehicle for saving and accumulating assets. It helps to refresh our understanding of some key terms:

Qualified Retirement Plans are those that meet ERISA guidelines. ERISA is the Employee Retirement Income Security Act, enacted in 1974 to protect workers’ retirement income and provide them with adequate information to make decisions about participating. Examples of qualified plans include 401(k) and 403(b). However, the 403(b) and other Tax Sheltered Annuity (TSA) plans can remain outside the "qualified" status by choosing plan administration options.

If the TSA sponsor does not match employee contributions, it is exempt from the ERISA provisions, which allows the employer to reduce reporting. The exemption also allows the 403(b) to sidestep nondiscrimination testing required of 401(k) plans. Such testing is designed to ensure that all employees receive the same benefits under the program.

A tax-sheltered annuity is an investment that facilitates employees’ ability to contribute before-tax income into a retirement account. TSAs are often offered to employees of public schools and other tax-exempt organizations and are considered qualified under ERISA. When the employer also contributes or matches the employee amount, that is also not taxed. Long ago, tax-sheltered annuities were only paid out to retirees as genuine annuity payments, meaning that the payment is guaranteed for the remainder of the individual's lifetime (this is also known as a defined benefit, as opposed to a defined contribution plan). This component became optional in 1974 and is much less common today.

403(b) is a common tax-sheltered annuity plan in the United States. In addition to schools, it is popular with churches and other 501(c)(3) non-profit organizations.

IRAs are individual retirement accounts. These were established for taxpayers who did not have access to employer-sponsored retirement accounts. If you can contribute to an employer-sponsored plan, you face limits on your ability to also contribute to a traditional IRA.

Roth IRAs are funded with post-tax dollars. As a result, contributions can be withdrawn at any time without incurring a penalty or additional taxes. Earnings, however, can only be withdrawn tax-free after the taxpayer has reached age 59.5.  

What is the Difference between a TSA and a 401(k)?

The primary difference between the two plans is the type of employer that offers them.  401(k) plans are offered by private companies, while the TSA is generally the province of non-profit organizations, schools, colleges, and government bodies.

Another distinction is the TSA sponsor's ability to choose to avoid "qualification" under ERISA, as discussed previously. This decision offers the employer some flexibility. Another notable difference is found in the administration. 401(k) programs are frequently overseen by mutual fund managers and have many choices for investment preferences. TSAs are often under the umbrella of an insurance company and offer more limited investment choices than the typical 401(k).

More Alike than Different

While TSAs and other 403(b) plans have some facets that set them apart from the more common 401(k), all the retirement programs share some standard components:

  •   Both offer tax-deferred retirement savings.
  •   Both have the same fundamental contribution limits.
  •  Both offer catch-up provisions.
  •  Both require participants to reach age 59.5 before taking distributions without penalty.
  •  Both have loan and hardship withdrawal options in many cases.
  •  Both require participants to begin withdrawing by age 72 in most cases.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.

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