A tax-sheltered annuity plan, also called a 403(b) plan, is a retirement program offered by certain tax-exempt organizations. These organizations are usually public schools, churches and hospitals. Whereas 401(k) plans are provided by for-profit companies, only organizations that meet Section 403(b) of the Internal Revenue Code can offer tax-sheltered annuity plans.
If you work for a tax-exempt organization that carries a tax-sheltered annuity plan, you can participate in the program. You may fund your account with pre-tax money, which gives you tax savings. In this case, you do not pay federal, and in most cases state, income tax on your contributions, only Medicare and Social Security taxes. You must, however, pay income tax on your contributions when you eventually make withdrawals from the plan. If your employer’s plan includes a Roth 403(b) option, you can fund your account with after-tax money. In this case, though you pay income taxes on contributions, you do not pay taxes on those funds when you make withdrawals from the plan.
In 2013, you can sock away up to $17,500 in your tax-sheltered annuity plan, plus an additional $5,500 if you are age 50 or older. If your employer matches your funds, your annual limit is $51,000. You might contribute more if your employer’s plan allows it and if you have at least 15 years of service with an IRS-approved organization. In this case, your limit may be increased by the smaller of $3,000, $15,000 minus the contributions you made in previous years due to this rule, or $5,000 multiplied by your years of service minus your total contributions made in previous years.
You may use mutual fund custodial accounts or annuities to fund your tax-sheltered annuity account. With a custodial account, one financial institution holds your funds in your account for you. Annuities, which can be fixed or variable, are financial agreements with an insurance company that are used to pay you regular income when you retire or to generate assets for your retirement. Your employer should give you a list of investment options that are available to you. Seek professional advice if necessary.
Job Termination and Withdrawal
If you no longer work for your employer, you can leave your money in your 403(b) account, roll it over into your new employer’s retirement plan or an Individual Retirement Account, or withdraw your money. If you withdraw, you might have to pay a 10 percent tax penalty if you are younger than 59½, plus pay 20 percent in federal income tax if you are not rolling the funds over into a qualified retirement plan. When you retire, based on your investment option, your payout may happen as a lump-sum amount or regular payments over an indefinite period.
If you fund your account with pretax money, your employer does not include your contributions in the taxable federal wages stated in Box 1 of your annual W-2. If you pay with after-tax money, your employer must include your contributions in Box 1. In both cases, your employer must report your retirement payments under code E in Box 12 and check Box 13 that says “Retirement Plan.” If you receive qualified withdrawals, they are taxed as ordinary income, so you must report the amounts on your tax return. In this case, the 403(b) vendor should send you a Form 1099-R that reflects your withdrawal amount.