Tax Sheltered Annuity
Employees of a public school system or a tax-exempt employer qualifying under Section 501(c)(3) of the code may be eligible to receive special income tax reductions under an approved savings program using Tax Sheltered Annuities (sometimes called Tax Deferred Annuities).
You may defer
a portion of your taxable income (within limits) by means of a salary reduction
agreement with the employer, or you may direct your employer to apply a salary
increase toward the purchase of a Tax Sheltered Annuity for the employee's
benefit. There are three extremely
valuable tax benefits under the provisions of the Tax Sheltered Annuity program:
NO CURRENT TAX ON INCOME
You do not pay current income tax on the portion of your earned income allocated to the annuity.
NO CURRENT TAX ON ACCUMULATED EARNINGS
All earnings on the funds accumulated in the account are exempt from income tax until benefits are received.
TAX DEFERRAL AFTER RETIREMENT
Even after retirement, all the funds still remaining within your TSA account will continue to enjoy tax-free earnings. You pay tax only on the amounts withdrawn, and you can postpone this until age 70 if desired.
AMPLIFIED INVESTMENT GROWTH
This tax favoritism allows a Tax Sheltered Annuity to
grow at extremely attractive rates compared to personal savings, which must be
funded with after-tax dollars, and on which earnings will be substantially
reduced by taxes on all the earnings.
Funds must be placed in an annuity policy issued by a life insurance company, or in a mutual fund account which has certain administrative provisions for such employee benefit plans.
· Fixed Return Annuities
These contracts have a guaranteed rate of return, and the balance of the account is also guaranteed. The insurance company will issue a guaranteed rate for a period of time ranging from three months to six years. While they have the ability to raise or lower the rate, the value of your account is not subject to fluctuation.
· Variable Annuities
These contracts are similar to a mutual fund, but have an annuity-insurance wrapper that adds features and benefits. The insurance company offers life expectancy retirement options and will also provide that in the event of the policy owner's death, the benefit will be not less than the amount contributed.
Funds are directed by the account holder to one or more of the investment accounts offered by the insurance company. These are separate accounts, and not co-mingled with the general funds ofthe insurer. Therefore, they are not subject to risk based on the solvency of the company.
The sub-accounts are like mutual funds, and may be invested in common stocks, government bonds, corporate bonds, etc. Each account will have a stated investment philosophy and a prospectus will provide further information. Policy owners may switch funds from one fund to another, with minimal restrictions.
· Mutual Funds
Generally these are within a "family" of funds that gives the owner the opportunity to switch from one to another. The full detail on these accounts will be contained in the prospectus.
The mutual funds, like the equity accounts of the variable annuity, are subject to market fluctuation. There are no guarantees. However, the general performance of these funds and variable annuities have been substantially greater than the rate of inflation or the fixed rates.
Since the Tax Sheltered Annuity is a long-term retirement vehicle, investment in equity accounts is generally advisable for all except those who are extremely risk-averse.
As a general rule, you may contribute up to 16% of your earnings through these reductions, but special formulas must be used to calculate your exact "exclusion allowance" permitted by the IRS.
Benefit payments are taxable only when received, usually after retirement when most people are in a lower tax bracket. Funds can also be withdrawn prior to formal retirement, but at that time they would be taxable as income.
The Tax Sheltered Annuity can provide a guaranteed retirement income that cannot be outlived. You may select options including income arrangements that provide for continuing income to your spouse or income plans designed to adjust with inflation.
The way in which federal income taxes are calculated has changed dramatically. The changes are significant and far reaching. Included in the revisions are a large number that affect tax-favored retirement plans, including Tax Sheltered Annuity( TSA) and Individual Retirement Accounts, which are treated in a similar fashion.
The new tax laws changed rules applicable to all types of individual and employer provided retirement plans, including Tax Sheltered Annuity plans.
Fortunately for the many public education and certain non-profit organization's employees eligible for tax sheltered annuity plans, the changes preserved TSAs as one of the most effective ways to save money for retirement financial security.
The new rules took effect at various times between January 1987 and 1989. Generally, they fall into two types:
REVISED LIMITS ON CONTRIBUTIONS
Prior to the 1986 Tax Reform Act, the maximum combined contribution an employee and employer could make to all retirement plans, including a TSA plan, was to up $30,000 per year. This all-plan limit remains and has been increased to $44,000 as of 2006.
The maximum before-tax salary reduction an employer may have is calculated in the same manner as before. However, there is now a new annual maximum of $15,000.
If you have 15 or more years of non-profit service profit, the maximum may be up to $20,000 per year, or an extra $5,000, until a total "make-up" reduction of $20,000 is reached. This feature gives you the opportunity to make contributions for prior years of service with a non-profit employer.
TSA contribution is also reduced by any contribution made by salary reduction to
a government employer provided Deferred Compensation Plan under IRC Section 457
or any plan of cash or deferred arrangement under IRC Section 401(k).
EXCISE TAX ON EARLY DISTRIBUTIONS
Payments or withdrawals made from a TSA plan have already been taxable as ordinary income prior to the new tax law. The tax bracket could have been as high as 50%.
Starting with 1987, these withdrawals are still subject to ordinary income tax on payments from your TSA, but at much lower rates. However, with the much lower ordinary income tax rates, there will also be an additional federal income tax equal to 10% of your TSA payments unless:
RESTRICTIONS ON DISTRIBUTIONS
To make the rules applicable to payments from a TSA
plan similar to those applicable to other types of retirement plans, such as the
popular 401(k) plans provided by corporate employers, new rules were imposed in
1989. These limit the events under which participants
may receive elective deferrals, such as salary reduction amounts, from a TSA
The payments made under this provision will generally be limited to your contributions only and not the earnings or any contribution made directly by your employer.
Note that the restrictions on distributions that took effect in 1989, operate independently of distributions that were pre-1989.
DISTRIBUTIONS STARTING AGE 70 1/2 OR BEFORE
Under prior law you usually did not have to start to receive a TSA account until age 75 or even later. Under the new law, effective in 1989, you must begin receiving benefits by April 1 of the calendar year following the calendar year in which you attain age
You must draw
enough funds from your TSA each year so as to exhaust the funds over your
lifetime or the joint lifetimes of you and your spouse.
To the extent that insufficient funds are withdrawn, you could be subject
to a 50% excise tax in the amount that should have been withdrawn.
LOANS FROM TSA PLANS
The new law provides for a maximum loan of 50% of
your account balance up to $50,000, less any loan amount outstanding during the
previous 12 months.
The loan must be repaid in five years. The repayment period maybe longer if the loan is used to acquire your principal residence. The new law requires that the loan be repaid on a level amortization of principal and interest over the period of the loan, with at least quarterly payments.
The interest payable will not be tax deductible. Residence rehabilitation loans and loans for residences of family members of participants are no longer permitted.
Tax Disclaimer: To ensure compliance with IRS Rules, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.
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Wink Tax Services / Wink Inc.