Withdrawing From a Tax-Sheltered Annuity

Learn about your options and their tax consequences before withdrawing money from a tax-sheltered annuity.

Learn about your options and their tax consequences before withdrawing money from a tax-sheltered annuity.

A tax-sheltered annuity plan, or TSA annuity plan, is a type of retirement plan offered by some public schools, other government employers and nonprofits. It functions similarly to 401(k) retirement plans at for-profit employers. Such a plan is often called a 403(b) retirement plan after the section of the tax code that defines it.

Tip

If you withdraw money from a tax-sheltered annuity before you reach the retirement age, you can face a tax penalty as well as owing income tax on the money you withdraw. There are some exemptions for emergency hardship situations.

Tax-Sheltered Annuity Plans

Some government agencies and nonprofits offer retirement plans called tax-sheltered annuity plans, TSA annuities or 403(b) plans. All of these refer to the same type of retirement plan.

As with 401(k) accounts at private, for-profit employers, you can contribute money to the plan and not pay tax on it until you withdraw it from the plan, usually at retirement age. There are also Roth 403(b) plans that enable you to pay tax on the money you put into the plan the year you earn it but not pay tax on any earnings when you withdraw it. That can be helpful if you expect you'll be in a higher tax bracket when you retire.

There are usually limits on how much you can put into a 403(b) plan each year, and your employer may give you various options to have contributions deducted from your paycheck. You may also have a choice of various mutual funds, such as stock or bond funds, in which the money you contribute can be invested. Research your plan to make sure your money is being invested the way you like.

Your employer may also match a portion of your contributions to the plan.

Withdrawals from a 403(b) Plan

Once you reach the retirement age of 59 1/2, you can take money out of the plan without facing a tax penalty. You will pay tax on the distributions as ordinary income.

You can also roll over money in a 403(b) to another 403(b) account at a new employer or into an IRA account. It's generally best to have the plan administrator roll the money directly into a new account to avoid tax withholding. If you have the money transferred to you, you generally will have 20 percent of it withheld for taxes and must deposit it in the new account within 60 days or face a 10-percent tax penalty. Work with your IRA provider and your employer or plan administrator to make the rollover directly.

If you leave your employer and take the money from your 403(b) account and deposit it in an ordinary bank account or investment account, you will owe the 10-percent penalty as well as income tax at your ordinary income rate on the withdrawn funds.

Hardship and Special Cases

If you're experiencing financial hardship or become disabled and need the funds before retirement age, you may be eligible for a penalty-free early distribution. If you're in the military reserves or the National Guard and you're called to active duty, you may also be eligible for such a distribution. You'll still owe tax on the money you withdraw, but you won't face the IRS penalty if you qualify.

If you're a retired public safety officer, such as a police officer or firefighter, you're also allowed to withdraw up to $3,000 per year to pay for accident, health or long-term care insurance for yourself, your spouse or your dependents. This money is entirely tax-free, so you don't pay a penalty or any federal income tax at all on those funds.

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Steven Melendez is an independent journalist with a background in technology and business.. He has written for a variety of business publications and was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism

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