Tax Sheltered Annuity: Essential Guide to Smart Savings

Let’s be real: most people hear “annuity” and their eyes glaze over. But a tax sheltered annuity (TSA) might be one of the smartest moves you can make if you work in education, healthcare, or the nonprofit sector. Here’s the thing—a tax sheltered annuity lets you stash money away before taxes are calculated, which means more of your paycheck stays invested instead of going to Uncle Sam. If you’re tired of watching your income shrink with every paycheck, this guide breaks down exactly how a tax sheltered annuity works, who qualifies, and how to use it to actually build real wealth.

What Is a Tax Sheltered Annuity?

A tax sheltered annuity is a retirement savings plan designed specifically for employees of schools, colleges, universities, and tax-exempt organizations like nonprofits and hospitals. Think of it like a subscription service for your future self—you set up automatic contributions from your paycheck, that money grows tax-free, and you don’t pay taxes on it until you withdraw it in retirement.

The IRS calls it a “403(b) plan,” named after the tax code section that created it. But the nickname “tax sheltered annuity” tells you exactly what it does: it shelters your money from taxes while it grows.

Here’s the emotional side: if you’re a teacher making $55,000 a year, you might feel like you’re barely scraping by. A tax sheltered annuity means you can invest pre-tax dollars, which reduces your taxable income right now. That’s not just about retirement—it’s about having more breathing room in your current paycheck. Learn more about maximizing your paycheck to see how this fits into your overall strategy.

Pro Tip: If you contribute $300/month to a tax sheltered annuity and you’re in the 22% tax bracket, you’re saving $66/month in federal taxes alone. That’s $792 per year—money that stays in your pocket now.

How Does a Tax Sheltered Annuity Actually Work?

The mechanics are straightforward, but let’s walk through it step by step so you actually understand what’s happening to your money.

1. You choose a contribution amount: Decide how much you want taken from your paycheck before taxes are calculated. This is pre-tax money.
2. Your employer deducts it automatically: The money comes out of your gross pay, reducing your taxable income for the year.
3. The money goes into an investment account: You choose how it’s invested (usually through mutual funds or fixed/variable annuities offered by your employer’s plan).
4. It grows tax-free: Unlike a regular brokerage account, you don’t pay taxes on dividends, interest, or capital gains while the money sits there.
5. You pay taxes when you withdraw: In retirement (age 59½ or later, usually), you withdraw the money and pay income tax on the distributions at that time.

The key difference from a regular savings account: your money compounds without being taxed every year. If you invest $10,000 and it grows to $15,000, you don’t owe taxes on that $5,000 gain until you actually withdraw it. That’s the “sheltering” part.

According to the IRS.gov guide on 403(b) plans, these accounts are specifically designed to encourage long-term savings for public school employees, college and university employees, and employees of certain tax-exempt organizations.

Who Qualifies for a Tax Sheltered Annuity?

Not everyone can open a tax sheltered annuity—your employer has to offer one, and you have to work for the right type of organization.

• Public schools (K-12)
• Colleges and universities
• Hospitals and healthcare organizations (tax-exempt)
• Churches and religious organizations
• Nonprofits (501(c)(3) organizations)
• Cooperative hospital service organizations

• For-profit companies (they offer 401(k) plans instead)
• Government agencies (they offer 457(b) plans)
• Self-employed individuals (they use SEP-IRAs or Solo 401(k)s)

The frustrating part? Just because you work for a qualifying employer doesn’t mean the organization has set up a tax sheltered annuity plan. Many schools and nonprofits do, but some don’t. You’ll need to check with your HR department.

If you’re in education or nonprofit work and want to understand your full compensation picture, check out our guide on how much of your paycheck you should save.

Contribution Limits and Rules

The IRS sets annual contribution limits, and they change every year. For 2024, here’s what you need to know:

1. Standard limit: You can contribute up to $23,500 per year (this is the same as 401(k) limits).
2. Catch-up contributions: If you’re 50 or older, you can add an extra $7,500, bringing your total to $31,000.
3. Special “15-year rule”: If you’ve worked for the same employer for 15+ years, you might be able to contribute an extra $3,000 per year (up to a lifetime limit of $15,000 extra). This is unique to 403(b) plans and is one of their hidden superpowers.

Here’s where it gets real: these limits are per plan, not per employer. If you somehow have multiple tax sheltered annuities, your total contributions across all of them can’t exceed the annual limit. Most people have just one, so this isn’t a problem—but if you change jobs, make sure you’re not double-counting.

The contribution limit is indexed to inflation, so it typically increases by $500 increments. Check the IRS 403(b) contribution limits page each January to see the current year’s numbers.

Warning: If you over-contribute (put in more than the limit), the IRS will tax you twice on the excess—once in the year you contributed it and again when you withdraw it. It’s a mess. Set up your contributions carefully and track them.

Key Benefits and Real Drawbacks

• Immediate tax savings: Your contributions reduce your taxable income right now, which can lower your tax bill or increase your refund. This is real money in your pocket this year, not just someday in retirement.
• Tax-deferred growth: Your investments compound without annual tax drag. Over 30+ years, this compounds into serious money.
• Easy to set up: It’s automatic payroll deduction, so you don’t have to think about it. “Set it and forget it” investing actually works.
• The 15-year rule: That extra catch-up contribution available after 15 years of service is genuinely valuable and rarely talked about.
• Lower taxable income now: Contributing to a tax sheltered annuity can push you into a lower tax bracket, save you money on state taxes, and potentially make you eligible for other tax credits.

• Limited investment choices: You’re stuck with whatever investments your employer’s plan offers. If the options are mediocre, you’re out of luck. You can’t just pick any mutual fund you want like you could with an IRA.
• High fees: Some tax sheltered annuities have annuity contracts with high expense ratios and surrender charges. You could be paying 1.5% or more annually, which kills long-term returns. A 401(k) typically has lower-cost index funds available.
• Early withdrawal penalties: If you need the money before age 59½, you’ll owe income tax plus a 10% penalty (with some exceptions). This isn’t a rainy-day fund.
• Forced distributions at 73: You must start taking Required Minimum Distributions (RMDs) at age 73 (as of 2023), whether you need the money or not. This can push you into a higher tax bracket in retirement.
• No loan options: Unlike 401(k)s, most 403(b) plans don’t allow loans. If you need cash, you have to withdraw and take the penalty.

The honest take: a tax sheltered annuity is excellent if your employer offers low-cost investment options. If the plan is loaded with high-fee annuity contracts, you might be better off maxing out an IRA first (if you’re eligible) and then contributing to the TSA.

Tax Sheltered Annuity vs. 401(k): Which Is Right for You?

These two plans are similar in many ways, but there are key differences:

The bottom line: if you work for a school or nonprofit and your TSA offers low-cost mutual funds (expense ratios under 0.50%), it’s a no-brainer. If your plan is heavy on annuity contracts with high fees, compare it carefully to an IRA or Roth IRA, which give you complete control over investments.

For state-specific paycheck strategies, see our Texas paycheck guide for examples of how retirement contributions fit into overall tax planning.

Withdrawal Strategy and Tax Impact

Here’s where a lot of people mess up: they don’t think about the tax consequences of withdrawals until it’s too late.

1. Don’t touch it until 59½. Seriously. The penalty is brutal. If you need accessible savings, use a regular savings account or brokerage account.
2. Plan your withdrawal amount. If you’re going to be in a lower tax bracket in early retirement, take larger withdrawals then. If you’re going to work part-time, coordinate your TSA withdrawals with your income.
3. Consider the Roth conversion ladder. Some people convert their traditional TSA to a Roth IRA in early retirement when their income is low, paying taxes at a low rate. It’s complex, but it can save serious money.
4. Remember Required Minimum Distributions. At age 73, you must withdraw a certain percentage. If you don’t need the money, this can be painful from a tax perspective.

According to Investopedia’s guide on Required Minimum Distributions, failing to take your RMD results in a 25% penalty on the amount you should have withdrawn (as of 2023). That’s brutal, so set a calendar reminder.

Pro Tip: If you have both a traditional TSA and a Roth IRA, you can be strategic about which account you withdraw from each year. In low-income years, withdraw from the traditional account. In high-income years, withdraw from the Roth (which has no tax consequences). This is called “tax bracket management” and it can save you thousands.

Getting Started with a Tax Sheltered Annuity

Ready to set up a tax sheltered annuity? Here’s the actual process:

1. Check if your employer offers one. Contact your HR or benefits department. Ask specifically: “Does our organization offer a 403(b) plan?” If yes, ask for the plan documents and a list of investment options.
2. Review the investment options. Look at the expense ratios. Anything under 0.50% is good. Anything over 1.00% is expensive. Compare the options to low-cost index funds you could buy in an IRA (like those at Vanguard or Fidelity).
3. Decide how much to contribute. Don’t just guess. Use a retirement calculator to see how much you need to save. As a rough rule, aim to replace 70-80% of your pre-retirement income. See our guide on how much of your paycheck to save for a personalized approach.
4. Fill out the enrollment form. Your HR department will give you a form. You’ll specify your contribution amount (as a dollar amount or percentage of salary) and how to invest it.
5. Set it and forget it. The money comes out automatically. You’ll see the reduction in your paycheck, but you’ll also see the tax savings on your next tax return.
6. Review annually. Once a year, check your account balance and make sure your investments are still on track. Rebalance if needed.

If your employer doesn’t offer a TSA, don’t despair. You can open an IRA (Traditional or Roth) on your own through any brokerage. You won’t get the employer match (if your employer offers one), but you’ll have complete control over your investments.

For educators specifically, some states offer supplemental retirement plans. Check with your state’s education department or teacher retirement system.

Also review how TSAs interact with other tax-advantaged accounts. If you have union dues or other pre-tax deductions, make sure your total pre-tax contributions don’t exceed IRS limits.

Frequently Asked Questions

Can I contribute to both a 403(b) and an IRA?

– Yes, you can contribute to both. However, if you have a 403(b), your IRA contribution deduction might be limited if your income exceeds certain thresholds. For 2024, if you’re covered by a workplace retirement plan and your income is over $77,000 (single) or $123,000 (married filing jointly), you can’t deduct Traditional IRA contributions. You can still contribute to a Roth IRA if your income is below the Roth limits. Check with a tax professional to be sure.

What happens to my 403(b) if I change jobs?

– Your money stays invested in the account. You have several options: (1) Leave it where it is and let it continue growing, (2) Roll it over to your new employer’s 403(b) or 401(k) if they allow it, (3) Roll it over to a Traditional IRA, or (4) If you’re over 55 and separated from service, take distributions penalty-free under the “Rule of 55.” The rollover option is usually best because it keeps your money in a tax-advantaged account and might give you better investment options.

Can I withdraw money from my 403(b) before retirement?

– Generally, no—not without penalties and taxes. You can withdraw before 59½ only in specific hardship situations (medical expenses, home purchase, education costs), and even then, you owe income tax plus a 10% penalty. Some plans allow loans, which let you borrow from your own account and repay it with interest—that’s better than a withdrawal if your plan offers it. But first, exhaust other options like emergency savings or a personal loan.

Is a 403(b) the same as an annuity?

– A 403(b) is the plan type (named after the tax code). Inside a 403(b), you can invest in mutual funds OR annuity contracts. Many people use the terms interchangeably, but they’re not quite the same. An annuity is an insurance product that guarantees a certain payout. A 403(b) with mutual funds is just a regular investment account. Ask your employer which one you have—if it’s an annuity contract with high fees, consider rolling it to an IRA with lower-cost mutual funds.

What’s the difference between a traditional and Roth 403(b)?

– Traditional 403(b): You contribute pre-tax money (reduces your taxable income now), and you pay taxes on withdrawals in retirement. Roth 403(b): You contribute after-tax money (no tax deduction now), and withdrawals are completely tax-free in retirement. The Roth is better if you think you’ll be in a higher tax bracket in retirement or if you want tax-free income flexibility. The traditional is better if you need the tax deduction now. Many people do both if their plan allows it.

Can I take a loan from my 403(b)?

– It depends on your plan. Some 403(b)s allow loans, others don’t. If your plan allows it, you can usually borrow up to 50% of your vested balance (up to $50,000). You repay the loan with interest (typically prime rate + 1-2%). If you leave your job, you usually have to repay the loan quickly or it becomes a taxable withdrawal. Loans are better than early withdrawals because you don’t pay the 10% penalty, but they’re still not ideal because you lose the growth on that money.

Do I get an employer match with a 403(b)?

– Not always. Some employers offer a match (like $0.50 for every dollar you contribute, up to a certain percentage), but many nonprofits and schools don’t. If your employer offers a match, contribute at least enough to get the full match—it’s free money. If they don’t, a 403(b) is still valuable for the tax deferral, but you might also want to max out an IRA if you’re eligible.

How do I know if my 403(b) has high fees?

– Look at the expense ratio of each investment option. It should be listed in the fund’s prospectus or on your plan’s website. Anything under 0.20% is excellent (like a Vanguard index fund). 0.20-0.50% is good. 0.50-1.00% is acceptable. Over 1.00% is expensive. If you see “annuity” products with expense ratios over 1.50%, those are very expensive and you should avoid them if possible. If your entire plan is expensive, ask HR if you can roll it to an IRA.

What happens to my 403(b) if I die?

– Your beneficiary (whoever you named on the account) inherits the money. They’ll owe income taxes on distributions, but they can stretch out the withdrawals over time to minimize the tax hit. If you didn’t name a beneficiary, the money goes through your estate, which is slower and messier. Make sure your beneficiary designation is current—it should be in your plan documents.