Legal Definitions - tax-sheltered annuity

Tax-Sheltered Annuity

A tax-sheltered annuity, often referred to as a 403(b) plan, is a special type of retirement savings plan available to employees of public schools and certain tax-exempt organizations, such as non-profit hospitals, charities, and religious institutions. It allows eligible employees to contribute a portion of their pre-tax salary into an investment account, typically an annuity or mutual fund. The key benefit is that these contributions, and any earnings they generate, are not taxed until the employee withdraws them in retirement. This "shelters" the money from current income taxes, allowing it to grow more rapidly over time.

• Example 1: A Public School Teacher Saving for Retirement

  Sarah is a high school history teacher at a public school. Each month, she elects to have a portion of her paycheck automatically deducted and invested into her 403(b) plan. Because these contributions are made before taxes are calculated on her income, her taxable income for the year is reduced. The money she contributes, along with any investment growth, accumulates over her career without being subject to annual income tax. When she retires and begins taking distributions, that money will then be taxed as ordinary income.

  This illustrates a tax-sheltered annuity because Sarah, as an employee of a public school, is eligible for this specific type of retirement plan. Her contributions reduce her current taxable income, and her investments grow without being taxed until she withdraws them in retirement, effectively "sheltering" them from immediate taxation.

• Example 2: A Nurse at a Non-Profit Hospital

  David works as a registered nurse for a large non-profit hospital system. He decides to enroll in the hospital's 403(b) plan to save for his future. He contributes a set amount from each paycheck, which is deducted before income taxes are withheld. Over many years, his contributions and the returns on his investments grow significantly. He doesn't pay taxes on this growth year after year. When he eventually retires, he will begin to pay taxes on the money he withdraws from his 403(b) account.

  This demonstrates a tax-sheltered annuity because David is employed by a qualifying tax-exempt organization (a non-profit hospital). His pre-tax contributions and the tax-deferred growth of his investments allow him to save for retirement while deferring tax obligations until a later date, which is the core feature of a tax-sheltered annuity.

• Example 3: An Administrator at a Charitable Foundation

  Maria is an administrator for a major charitable foundation that is recognized as a 501(c)(3) tax-exempt organization. She participates in the foundation's 403(b) plan. Each pay period, she allocates a percentage of her gross salary to her retirement account. This reduces her current taxable income, and the funds she invests, along with any interest or capital gains, are not taxed annually. This allows her savings to compound more effectively. She plans to access these funds during her retirement years, at which point they will be subject to income tax.

  This example highlights a tax-sheltered annuity because Maria works for a qualifying tax-exempt charitable organization. Her ability to contribute pre-tax dollars and have those investments grow without immediate taxation until retirement perfectly aligns with the definition and benefits of a tax-sheltered annuity.