Traditional individual retirement arrangements -- better known as IRAs -- and tax-sheltered annuities or TSAs, which most often show up as 403(b) workplace retirement plans for nonprofit organization workers and some public employees, offer tax advantages as you save for retirement. The contribution limit is the key difference between the two, but there are other distinctions to consider as well.
The IRS sets contribution limits for allowable retirement plans each year. For 2012, you may contribute up to $17,000 in pre-tax funds into a 403(b) plan, plus another $5,500 in catch-up contributions if you're at least age 50. In addition, your employer may add tax-deferred matching funds to your TSA. Beginning in 2012, the contributions from you and your employer may total $50,000 or your full salary, whichever is smaller. IRA contributions are capped at $5,000, although if you're at least 50 you're allowed a $1,000 catch-up contribution.
There are no income limits restricting contributions to a TSA, while the deductibility of contributions to IRAs generally phases out at certain income levels if you have access to a qualified retirement plan, such as a TSA, at work. The IRS allows after-tax contributions to either IRAs or TSAs, but many TSA plans do not permit after-tax contributions because they require more extensive accounting.
Deductible IRA Income Limits
If you are covered at work by a TSA, you may make tax-deductible contributions to an IRA in addition to -- or instead of -- contributions to your TSA if your income stays below the income limits the IRS sets annually. If you are single, you may not deduct an IRA contribution for 2012 if your modified adjusted gross income climbs above $68,000, and the deduction begins to phase out at $58,000. For married persons, the income range stretches from $92,000 to $112,000. If your spouse has access to a workplace retirement plan and you don't, you may make a fully deductible IRA contribution if your joint income is under $173,000 with the deduction gradually phasing out at an income of $183,000.
Tax-sheltered annuities typically include a vesting or holding period during which you may not access the money -- sometimes even as a rollover to an IRA or a new employer's retirement plan -- without being penalized. However, TSA plans typically include provisions for you to take loans up to $50,000 against your account, which you may pay back over an extended period. Loans are not allowed with an IRA, but you may take out money tax-free and penalty-free for up to 60 days before replacing the funds in your account.
With tax-sheltered annuities you may choose only from those investments -- usually a limited number of mutual funds -- offered by your company's plan. Self-directed IRAs let you pick from a wide range of investments. Cash, common stocks, mutual funds, bonds, exchange-traded and close-end funds are the most common, but you also may invest in real estate, private partnerships, limited liability companies and commodities.
Distributions from IRAs and TSAs are taxed as ordinary income, and withdrawals before you turn 59 1/2 will typically result in a 10 percent penalty. Both will require you to take minimum annual distributions -- which, of course, will be taxed -- beginning the year you turn 70 1/2. However, a 403(b) tax-sheltered annuity includes one provision not allowed in an IRA: If you remain with your 403(b) employer until age 50 and you leave your assets in the 403(b), you may access the money without penalty at age 55 as long as you no longer work for that employer. You lose this privilege if you roll over your 403(b) into an IRA, Roth IRA or another employer's plan, and you will incur the 10 percent penalty for all distributions taken before the rollover.