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What is the difference between a tax SHELTERED annuity and a tax DEFERRED annuity?

Although sometimes deferred and sheltered are used interchageably, when someone is talking about a tax sheltered annuity they are more than likely referring to a 403B plan or a TSA (tax sheltered annuity) plan. Available exclusively for employees of government institutions such as public schools or universites as well as certain 501(c)(3) tax-exempt organizations like churches or some hospitals , this is a tax-sheltered annuity designed as a retirement savings plan

The contributions for a TSA are taken from the employees paycheck before federal or state income taxes, by the employer (lowering the taxable income) and are deposited directly into individual accounts.  These contributions are typically matched by the employer up to a certain amount per year. Because the employer can also make direct contributions, the employee gains the benefit of having additional tax-free funds, accruing in that investment.

These contributions, and any gains earned, are not taxed until the employee begins making withdrawals from the plan.   When money is withdrawn it is taxed as regular income.

You have until April of the year after you turn 70 ½ before the IRS requires you to begin receiving income from your TSA, however, if you are still employed after you turn 70 ½, you may delay distributions until you do finally retire, continuing to pay into your account through your employer, if you wish.

 

 

Now let's compare this to a tax-deferred annuity.

An annuity is really a contract between an individual and an insurance company that provides that individual with tax-deferred wealth accumulation and an option to either receive a lump sum or fixed payments starting on a specific date.

The most common types of deferred annuities are: single or multiple premiums and fixed or variable.

For a single premium contract, you pay the insurance company only one payment, whereas you make a series of payments for a multiple premium. Fixed or variable has to do with how your rate of return is calculated. During the accumulation period of a variable annuity, you decide how the company will invest your funds based on how much risk you are willing to take. For detailed information on fixed or variable annuities click here.

The income payments from a deferred annuity often start many years later. Deferred annuities have an accumulation period for a set amount of time, usually between five and ten years. During that time, the taxes on any gains are deferred until you begin taking a withdrawal. During the payout period, the amount of each income payment to you is generally set when the payments start and will not change.  You can choose to receive payments monthly, quarterly, semiannually or annually. You can receive a specific period of time in which to receive payments. You can also choose an option that will guarantee income payments for as long as you live.

Earnings on a deferred annuity are only taxed upon withdrawal, however, under most circumstances, withdrawals made prior to age 59 ½ are generally subject to a 10% IRS penalty tax and may be subject to charges.

Another common feature of deferred annuities is the option of adding a death benefit so that your beneficiaries are guaranteed the principal and the investment earnings upon your unfortunate demise.

In the end, determining whether or not a deffered annuity is the right investment shouldl be based on an investor's financial goals and tax situation and with the expert assistance of a trusted financial advisor.

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