Tax-free retirement distributions sounds great, but it isn't right for everyone. If your employer allows you to save for retirement through a tax-sheltered annuity, such as 403(b) plan, you may have the ability to contribute to both a pre-tax TSA or Roth TSA. Knowing how the plans work helps you determine which is best for you.
Contributions to a regular TSA are taken straight from your paycheck and are not included in your taxable income when you receive your W-2 at the end of the year. Essentially, it has the same effect as if you were able to deduct the amount of your contribution. For example, if you contribute $8,000 when you fall in the 28 percent tax bracket, your contribution saves you $2,240 in taxes. With a Roth TSA contribution, you don't get any benefit on your taxes for your contributions because your contributions are made with after-tax dollars.
Matching contributions to a regular TSA can be added to the same account. However, when you contribute to a Roth TSA, employers cannot put the matching contributions for your contributions into the same account because employer matches cannot be made into a Roth account. Instead, a separate, regularly TSA must be set up for you so that when you contribute to a Roth TSA, the employer match goes into a regular TSA.
Qualified withdrawals from regular TSAs occur after you turn 59 1/2. Since you received a tax break for your contributions, the distributions are taxable as ordinary income. For Roth TSAs, not only do you have to be 59 1/2, you also have to have had the account open for 5 years before you can take qualified distributions. However, once you do qualify, you can remove all the money you want from the Roth TSA completely tax-free, including gains on your original investment.
Early withdrawals are also treated differently between TSAs and Roth TSAs. An early withdrawal is any withdrawal that doesn't meet the requirements to be a qualified withdrawal. Early TSA withdrawals are fully taxable and subject to the 10 percent additional tax. Roth TSA early distributions must be divided between your contributions, which are tax-free, and your earnings, which are taxable and subject to the 10 percent additional tax. To figure the ratio between contributions and earnings, look to your account balance. For example, if 64 percent of your account balance is from your contributions, leaving 36 percent for earnings, 64 percent of your early withdrawal is tax-free and the remaining 36 percent is taxable and gets hit with the 10 percent additional tax.
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