Tax Sheltered Annuity: The Complete Guide to Smart Savings

If you work in education, healthcare, or a nonprofit organization, you’ve probably heard someone mention a tax sheltered annuity (TSA) in the break room. Maybe it sounded complicated. Maybe it sounded too good to be true. Here’s the real talk: a tax sheltered annuity is one of the smartest retirement moves available to public and nonprofit employees, and it’s way simpler than it sounds.

Think of a tax sheltered annuity like a subscription service for your retirement. You contribute pre-tax dollars directly from your paycheck, your money grows tax-free, and you don’t pay taxes until you withdraw it in retirement. For eligible employees, this can mean thousands of dollars in tax savings over your career.

In this guide, we’ll walk through exactly how a tax sheltered annuity works, who qualifies, how much you can contribute, and whether it makes sense for your situation. No jargon. No fluff. Just straight answers.

What Is a Tax Sheltered Annuity?

A tax sheltered annuity is a retirement savings plan designed specifically for employees of public schools, colleges, universities, and nonprofit organizations (IRC Section 403(b)). It allows you to set aside money from your paycheck before taxes are calculated, which reduces your taxable income for the year.

Here’s how it works in practice: Your employer deducts your TSA contribution directly from your gross paycheck. That money goes into an investment account (either an annuity contract or mutual fund) where it grows tax-free. You don’t pay federal income tax on that money until you withdraw it in retirement, typically after age 59½.

The result? You pay less in taxes today, your money compounds tax-free for decades, and you end up with a larger retirement nest egg. It’s one of the few ways the IRS actually encourages you to save more.

Pro Tip: If your employer offers a matching contribution (some nonprofits and schools do), that’s free money. Max out the match before you worry about anything else. It’s an instant 100% return on your investment.

A tax sheltered annuity is different from a traditional IRA or 401(k), though they work on similar principles. TSAs are exclusively for nonprofit and public sector employees, which means the rules are tailored to those specific situations.

Who Qualifies for a Tax Sheltered Annuity?

Not everyone can open a TSA. Your employer has to offer one, and you have to work for an eligible organization. Here’s the breakdown:

• Public school teachers and staff (K-12 and higher education)
• College and university employees (faculty, staff, administrators)
• Nonprofit organization employees (501(c)(3) organizations, primarily)
• Certain government employees (some state and local government workers)

If you work for a for-profit company, you’re not eligible. If you work for a nonprofit but your organization hasn’t set up a TSA plan, you’re stuck unless you push your HR department to establish one.

Here’s the thing: even if you’re eligible, your employer has to have a TSA plan in place. Some schools and nonprofits are slow to set these up, which is frustrating because eligible employees are leaving money on the table. If your organization doesn’t have one, it might be worth asking your HR or finance department about establishing a plan. Many vendors (like Fidelity, Vanguard, and TIAA) make it relatively easy to set up.

You also need to be a common-law employee of the organization. If you’re a contractor or 1099 independent contractor, you don’t qualify for a TSA, even if you work for a nonprofit. (Though you might qualify for a SETC Tax Credit or a Solo 401(k) instead.)

2025 Contribution Limits for Tax Sheltered Annuities

The IRS sets annual limits on how much you can contribute to a TSA. For 2025, the basic limit is $23,500 per year. That’s the same as a 401(k) limit, and it increases annually with inflation (usually by $500 increments).

But here’s where it gets interesting: TSAs have special rules that can let you contribute more.

• Catch-up contributions: If you’re 50 or older, you can add an extra $7,500 per year (total: $31,000)
• 15-year catch-up rule: If you’ve worked for your employer for 15+ years, you may be able to contribute an additional $3,000-$5,000 per year (depending on your salary history). This is exclusive to TSAs and is one of their biggest advantages.
• Employer match: Any employer contributions on top of your deferrals don’t count toward your personal limit

That 15-year catch-up rule is huge. If you’re a teacher or nonprofit employee who’s been with your organization for a decade and a half, you could potentially contribute $26,500-$28,500 instead of $23,500. Over time, that extra $3,000-$5,000 per year adds up significantly.

Warning: Don’t assume you know your exact limit. Work with your TSA provider or HR department to calculate your specific 15-year catch-up eligibility. The rules involve your salary history, and mistakes here can trigger IRS penalties.

Check with your plan administrator or IRS Publication 571 for the exact calculation if you think you qualify for the catch-up provision.

TSA vs. 403(b) Plans: What’s the Difference?

You’ll often hear the terms “TSA” and “403(b)” used interchangeably, and that’s because they’re essentially the same thing. Both refer to retirement plans for nonprofit and public sector employees under IRC Section 403(b).

Historically, TSAs were annuity-only products (hence the name), while 403(b) plans could include mutual funds. But today, that distinction is blurry. Most modern plans offer both options.

The real difference is in the investment vehicles available:

• Annuities: Guaranteed income stream, lower investment risk, but higher fees and less flexibility
• Mutual funds: More investment options, typically lower fees, but no guaranteed income

Your employer’s plan will specify which options are available. If your plan offers both, mutual funds are usually the better choice for younger employees because of lower fees. Annuities make more sense closer to retirement when you want guaranteed income.

For a deeper dive on tax-free retirement accounts in general, check out our guide on tax-free retirement accounts.

Investment Options Inside a Tax Sheltered Annuity

Once your money is in a TSA, you need to decide where it actually goes. Your employer’s plan will have a menu of investment options. Common choices include:

• Target-date funds: Automatically adjust risk as you approach retirement (best for hands-off investors)
• Index funds: Low-cost, broad market exposure (good for long-term investors)
• Bond funds: Lower risk, stable income (better for conservative investors or those nearing retirement)
• Money market funds: Very safe but low returns (only for short-term money)
• Annuities: Guaranteed payments in retirement (good for risk-averse investors)

Here’s my honest take: most people overthink this. If you’re more than 10 years from retirement, a target-date fund that matches your expected retirement year is a solid, boring, effective choice. Set it and forget it.

The worst mistake is leaving your money in a money market fund or stable value fund because you’re “not sure what to do.” That’s basically guaranteeing your money won’t keep pace with inflation. You need growth, especially early in your career.

Pro Tip: Check your plan’s expense ratios (fees). Some TSA providers charge 0.5% annually, others charge 1.5% or more. Over 30 years, that difference compounds into tens of thousands of dollars. If your plan offers low-cost index funds, use them.

Withdrawal Rules and Penalties

This is where TSAs get strict. The IRS wants your money to stay in the plan until retirement, and they enforce that with penalties.

If your employer matches contributions, that’s free money. Contribute enough to get the full match, even if you can’t afford to max out the plan. A typical match might be 3-5% of salary. Don’t leave it on the table.

Your TSA contribution reduces your taxable income dollar-for-dollar. If you’re in the 22% federal tax bracket and contribute $10,000 to a TSA, you save $2,200 in federal taxes immediately. Plus state and local taxes (if applicable). That’s real money.

Use an online tax calculator to estimate your tax bracket, then work backward to figure out how much you’d need to contribute to drop to a lower bracket. For many teachers and nonprofit employees earning $40,000-$70,000, contributing $5,000-$10,000 annually can make a meaningful difference.

If you’ve been with your organization for 15+ years, calculate your catch-up eligibility. This is one of the few TSA advantages that many people don’t use. You could contribute an extra $3,000-$5,000 per year with minimal impact on your budget, but huge impact on retirement savings.

If you have a spouse with a 401(k) or if you have income from a side gig, think about how your TSA fits into your overall retirement picture. You can’t double-dip contribution limits across accounts, but you can strategically use multiple accounts to your advantage.

For example, if you have rental property income, you might contribute to a Solo 401(k) with that income while maxing out your TSA with W-2 income. (See our guide on rental property tax deductions for more on that.)

Your TSA is a long-term investment, but that doesn’t mean you should never look at it. Once a year, check:

• Are your funds still aligned with your risk tolerance and timeline?
• Have your plan’s fees changed?
• Are there new, lower-cost investment options available?

Rebalance if necessary, but don’t obsess over short-term market movements.

Your TSA withdrawals will be taxed as ordinary income in retirement. If you retire at 62 with a large TSA balance, a big withdrawal could push you into a higher tax bracket that year. Work with a tax professional to plan withdrawal strategies that minimize taxes in early retirement. You might spread withdrawals over multiple years, or coordinate them with Social Security claiming decisions.

Most states don’t tax retirement income, but some do. If you live in a state with income tax, your TSA contributions reduce both federal and state taxable income, which is a huge advantage. If you’re considering retiring to a tax-free state like Florida or Texas, that’s another factor in your retirement planning.

Pro Tip: If you’re a teacher or nonprofit employee considering a career change, think carefully before leaving your organization. You lose access to the TSA (and any employer match) once you’re no longer eligible. Plan your career transitions accordingly.

Frequently Asked Questions

Can I withdraw money from my TSA before age 59½?

– Technically yes, but you’ll owe income tax plus a 10% penalty on the withdrawal. There are narrow exceptions (disability, medical hardship, substantially equal periodic payments), but they’re difficult to qualify for. TSAs are designed for long-term retirement savings, so only contribute money you won’t need for decades.

What happens to my TSA if I leave my job?

– Your TSA balance stays in the account and continues to grow tax-free. You can’t make new contributions once you’re no longer employed by that organization, but you can roll the balance into an IRA or another employer’s 403(b) plan if you move to a new eligible employer. Don’t cash it out—that triggers taxes and penalties.

Is a TSA the same as a 403(b)?

– Yes, essentially. TSA stands for “tax sheltered annuity,” and 403(b) refers to the tax code section. Modern 403(b) plans can include both annuities and mutual funds. The terms are used interchangeably, though some people use “TSA” specifically for annuity-based plans and “403(b)” for the broader category.

How much should I contribute to my TSA?

– That depends on your situation. At minimum, contribute enough to get any employer match. Ideally, contribute 10-15% of your salary if possible. If that’s not feasible, start with whatever you can afford and increase contributions by 1% each year. Every dollar helps, and the tax savings make it less painful than you think.

Can I have both a TSA and a Traditional IRA?

– Yes, you can have both. However, your Traditional IRA contributions may not be tax-deductible if you’re covered by a TSA (depending on your income level). Check the IRS rules for your specific situation. A Roth IRA is a better option if you want tax-free growth alongside your TSA.

What’s the difference between an annuity and a mutual fund in a TSA?

– An annuity provides guaranteed income payments in retirement (like a pension), while a mutual fund is invested in the market and fluctuates. Annuities are safer but have higher fees. Mutual funds offer more growth potential but with market risk. For most younger employees, mutual funds are the better choice. Consider annuities as you approach retirement if you want guaranteed income.

Do I pay taxes on TSA growth?

– No, your money grows tax-free inside the TSA. You only pay taxes when you withdraw it in retirement. This is one of the biggest advantages—your growth compounds without annual tax drag, which significantly increases your final balance.

Can my employer match contributions to my TSA?

– Yes, some employers do. If your employer offers a match, it doesn’t count toward your personal contribution limit. So you could contribute $23,500 of your own money plus receive an employer match on top of that. Always ask your HR department if a match is available.

What happens to my TSA if I die?

– Your beneficiary (whoever you named on the account) inherits the balance. They can roll it into an inherited IRA or take a lump sum (which triggers income taxes). Make sure your beneficiary designation is current—it overrides your will, so update it if your circumstances change.

Can I borrow from my TSA?

– Most TSA plans don’t allow loans. Some 403(b) plans do, but it’s rare. If your plan allows loans, you’d typically borrow up to 50% of your balance (with a maximum of $50,000) and repay it over 5 years. Avoid loans if possible—they complicate your retirement planning and if you leave your job, the loan balance is treated as a distribution (triggering taxes and penalties).

Is a TSA better than a 401(k)?

– They’re similar, but TSAs have one major advantage: the 15-year catch-up provision. If you’ve worked for your employer for 15+ years, you can contribute more than someone with a 401(k). Otherwise, they’re comparable. If you’re eligible for a TSA and your employer offers one, use it. If you’re not eligible, a 401(k) is the next best thing.

How do I know if my employer’s TSA plan is good?

– Look at three things: (1) Are there low-cost index fund options (expense ratios under 0.20%)? (2) Does your employer match contributions? (3) Is the plan administrator reputable (Fidelity, Vanguard, TIAA, etc.)? If your plan has high fees and no match, it’s still worth using (the tax savings make up for it), but you’ll benefit less than someone with a better plan.