What Is a TSA Account?

A tax-sheltered annuity, or TSA account, is a type of tax-deferred retirement savings plan available for people who work for schools, tax-exempt organizations. It's also available for certain members of the clergy. The term "tax-sheltered annuity" is something of a relic, since people with such accounts can put their money into mutual funds in addition to annuities. They're more commonly known as 403(b) plans, after the section of the Internal Revenue Code that applies to them.

A 403(b) plan works much like the 401(k) plans offered by private employers. Workers contribute a portion of their wages to a retirement savings account, and their employer commonly makes a contribution as well -- typically by matching employee contributions up to a certain amount. The money in the account is invested, and the worker can withdraw funds later in life. Making 403(b) plans especially attractive is the special tax treatment that applies: All taxes are deferred until money is withdrawn from the account.

Contributions to a 403(b) account are made with before-tax dollars, meaning workers do not have to pay income taxes on the money they put in. Investment profits are also untaxed as long as that money stays in the account. Workers can begin to withdraw money from the plan -- referred to as "taking distributions" -- at age 59-1/2 or if they become disabled. Distributions are taxed as ordinary income. In short, putting money in a 403(b) allows workers to delay paying taxes on it for years, even decades.

The law that allows for 403(b) plans was written in 1958. Originally, the only investments allowed in such plans were annuities, usually sold by insurance companies. That's how these accounts came to be known as tax-sheltered annuities. In a classic tax-sheltered annuity, people contribute money tax-free during their working years, and that money is invested on their behalf. Upon retiring, they get regular payments, and those payments are taxed. The law was revised in 1974 to allow people to put 403(b) money into mutual funds as well as annuities, but the TSA name has stuck.

The owner of a 403(b) account can withdraw money before reaching age 59-1/2, but only by paying income taxes on it and a penalty of 10 percent of the withdrawal. The tax code allows, but does not require, employers to waive the penalty (but not the income tax) for "hardship distributions," when employees need the money for medical bills, a down payment on a house, tuition costs or certain other instances of "immediate and heavy financial need." Employers can also choose -- but again, are not required -- to allow participants to borrow money from their 403(b) accounts.