Annuities are financial products that provide a steady stream of income during retirement. They can offer various tax advantages, depending on their classification. Two common types of annuities are tax-sheltered annuities (TSAs) and non-qualified annuities (NQAs). In this blog post, I will explore the differences between these two annuities, including their tax treatment, eligibility requirements, contribution limits, and withdrawal rules.
Tax-Sheltered Annuity (TSA)
A tax-sheltered annuity, also known as a 403(b) plan, is a retirement plan available to certain employees of public schools, nonprofit organizations, and other tax-exempt organizations. TSAs are similar to 401(k) plans offered by for-profit companies, but they have specific eligibility requirements and contribution limits.
Eligibility: To contribute to a TSA, you must be employed by an eligible organization. These can include public schools, colleges, universities, hospitals, charitable organizations, and religious institutions.
Contribution Limits: TSAs have specific contribution limits set by the IRS. In 2023, the maximum contribution limit is $19,500, with an additional catch-up contribution of $6,500 for individuals aged 50 or older.
Tax Treatment: Contributions to a TSA are made on a pre-tax basis, meaning they are deducted from your taxable income in the year they are made. This reduces your current tax liability. However, withdrawals from TSAs are subject to ordinary income tax at the time of distribution.
Withdrawal Rules: TSAs have strict withdrawal rules. Generally, you cannot withdraw funds from a TSA before the age of 59 ½ without incurring a 10% early withdrawal penalty. Exceptions include cases of death, disability, or financial hardship. Required minimum distributions (RMDs) must start by April 1st following the year you turn 72 or retire, whichever is later.
Non-Qualified Annuity (NQA)
A non-qualified annuity (NQA) is a type of annuity that is not linked to an employer-sponsored retirement plan or a tax-exempt organization. NQAs are typically purchased directly from an insurance company, and they are not subject to the same contribution limits and eligibility requirements as TSAs.
Eligibility: NQAs are available to individuals regardless of their employment status or the type of organization they work for. They are often used by individuals who have maximized their contributions to other retirement plans or who do not have access to employer-sponsored plans.
Contribution Limits: NQAs do not have IRS-imposed contribution limits, which means you can contribute as much as you want to an NQA. However, keep in mind that large contributions may have tax implications in terms of the growth of the investment and potential estate taxes.
Tax Treatment: Contributions to an NQA are made with after-tax dollars, meaning they are not tax-deductible. However, the growth of the annuity is tax-deferred. This means that you are not required to pay taxes on the earnings until you start making withdrawals.
Withdrawal Rules: Unlike TSAs, there are no strict withdrawal rules for NQAs. You can generally withdraw funds from an NQA at any time without incurring an early withdrawal penalty. However, any earnings withdrawn before the age of 59 ½ may be subject to a 10% early withdrawal penalty and ordinary income tax.
Comparison and Considerations
Now that we have examined the key differences between tax-sheltered annuities and non-qualified annuities, let's summarize and consider a few factors that may help you make an informed decision:
Eligibility: TSAs are available to employees of eligible organizations, while NQAs are open to all individuals.
Contribution Limits: TSAs have IRS-imposed contribution limits, whereas NQAs have no specific limits set by the government.
Tax Treatment: Contributions to TSAs are tax-deductible, reducing current tax liability, while NQAs are funded with after-tax dollars. However, both TSAs and NQAs provide tax-deferred growth.
Withdrawal Rules: TSAs have strict withdrawal rules, with penalties for early withdrawals, whereas NQAs offer more flexibility in accessing funds.
Financial Goals and Needs: Consider your retirement goals, financial situation, and investment preferences when choosing between TSAs and NQAs. It's important to consult with a licensed financial professional to determine which option aligns best with your specific circumstances.
Choosing between a tax-sheltered annuity (TSA) and a non-qualified annuity (NQA) depends on your eligibility, contribution preferences, tax considerations, and withdrawal needs. While TSAs are designed for employees of tax-exempt organizations, NQAs are available to all individuals. Understanding the differences between these annuities will help you make an informed decision regarding your retirement savings. Remember, it's crucial to seek professional financial advice to ensure your retirement plan aligns with your long-term goals.
There is no better time to re-evaluate your current situation than the present. Connect with a licensed financial professional at Alfa Pride Financial, to assess where you are on your financial journey, and get the financial keys to a worry-free life. Get started today and book a call.
About the Author
Xavier Williams is a licensed financial professional and member of the National Association of Insurance & Financial Advisors. He specializes in protection, wealth-building, and wealth-preservation strategies. He helps clients across the U.S. protect their families and businesses with insurance and financial products to secure a brighter future.