Understanding Recent Changes to Tax Sheltered Annuities

Article Highlights:

• Key Benefits
• Contribution Limits for 2025
• Elective Deferral Limit
• Catch-up Contributions
• Combined Contribution Limits
• Avoiding Common Pitfalls
• Distribution and Rollover Rules
• Loans and Hardship Distributions
• Special Considerations

A 403(b) plan, also known as a tax-sheltered annuity, is a retirement savings program that many tax-exempt organizations and public education institutions offer to their employees. These plans are designed to supplement retirement income through pre-tax contributions from earnings. These plans offer a variety of tax advantages and facilitate long-term wealth accumulation through salary deferrals, employer contributions, or both. Contributions are generally tax-deferred, meaning participants don't pay taxes on them until they withdraw the funds at retirement. Additionally, the earnings on these contributions can grow tax-free until withdrawal.

Key Benefits

• Tax Deferral: Contributions made to a 403(b) plan reduce your taxable income for the year the contribution is made, thus lowering your overall tax liability for that year.
  
  
• Portability: These plans can often be rolled over into other eligible retirement accounts, such as an IRA or another 403(b), making them adaptable to your evolving career path.

Elective Deferral Limit

For 2025, the maximum amount you can elect to defer from your salary into a 403(b) plan without considering any catch-up contributions is $23,500. This amount changes periodically due to cost-of-living adjustments.

Catch-up Contributions

Two types of catch-up contributions are available to help you increase your retirement savings:

1. Age-50 Catch-up Contributions: If you are 50 years of age or older, you can make additional catch-up contributions. In 2025, this amount is $6,500 and tends to increase most years due to inflation adjustment. The aged-basis catch-up contribution is $11,250 if you are age 60, 61, 62 or 63 by the end of 2025.
   
   
2. 15-Year-of-Service Additional Contributions: For certain employees with at least 15 years of service with specific eligible employers(such as schools, hospitals and churches), additional contributions are possible within certain limits, potentially allowing an additional contribution of the least of $3,000, $15,000 less previously excluded special catch-ups, or $5,000 multiplied by years of service minus previously excluded deferrals.

Combined Contribution Limits

In addition to the limit on elective deferrals, annual contributions to all an employee’s retirement accounts – including elective deferrals, employee contributions, employer matching and discretionary contributions and allocations of forfeitures to the accounts - may not exceed the lesser of 100% of the employee’s compensation or for 2025$70,000.Also, the amount of compensation for 2025 that can be considered when determining employer and employee contributions is limited to $350,000.

The limit does not just apply to each 403(b) plan to which the employee makes elective deferrals, but instead applies to the aggregate amount of all the elective deferrals made by the employee for the year to all plans which permit such contributions, including:

• Code Sec. 401(k) deferred compensation plans,
  
  
• Code Sec. 408(k) SEP IRAs,
  
  
• Code Sec. 408(p)(2) SIMPLE Plans, and
  
  
• Code Sec. 403(b) annuity plans (TSAs)

However, Code Sec. 457 plans (government plans) are not included in the overall deferral limitations.

These amounts are annually adjusted for inflation. Contact this office for amounts other than 2025.

Mandatory Roth Contributions

Recent legislation provides that effective January 1, 2026, all catch-up contributions, if the participant’s Social Security wages for the prior year exceeded $145,000, must be designated Roth contributions.

In addition, if catch-up contributions are provided under a plan as designated Roth contributions for participants whose wages exceed $145,000, the plan must also permit catch-up contributions made by other eligible participants to be designated Roth contributions.

Avoiding Common Pitfalls

Engaging with a 403(b) plan requires awareness of common administrative and compliance errors to maximize its benefits and avoid penalties. Here are several areas where mistakes often occur:

• Universal Availability: If your 403(b) plan allows elective deferrals, it must offer the same opportunity to all eligible employees, with specific exceptions for certain employee categories.
  
  
• Exceeding Contribution Limits: Recognize both the age-50 and the 15-year-of-service catchup limits and ensure contributions do not surpass these thresholds. Any excess must be corrected to avoid taxes and penalties.
  
  
• Proper Deferral Handling: Employers must deposit your elective deferrals promptly within specified timeframes to ensure compliance.

Distribution and Rollover Rules

Distributions from a 403(b) plan generally occur when you retire, reach age 59½, or face other qualifying events such as disability or death. Early distributions may incur a 10% penalty tax unless exceptions apply, such as for hardships or qualified loans.

Regarding rollovers, participants can roll over eligible distributions to other 403(b) plans, 457(b) plans, or IRAs, providing extensive flexibility in managing retirement savings.

Loans and Hardship Distributions

Participants may face situations where accessing funds is necessary. Loans from your 403(b) plan can be an option. Hardship distributions are also available under strict IRS guidelines for immediate, heavy financial needs.

Special Considerations

• Post-Employment Contributions: Some plans allow for elective deferrals and even employer contributions post-employment within set timeframes.
  
  
• Plan-to-Plan Transfers: Transferring funds between approved annuity issuers within the same 403(b) plan can streamline keeping assets aligned with financial goals.

403(b) plans are a robust avenue for retirement savings, providing significant tax advantages and flexibility. With the adjustments to contribution limits in 2025, it's imperative for participants to remain informed and proactive in maximizing these benefits. Adhering to contribution limits, understanding the intricacies of your plan features, and staying alert to compliance requirements will ensure your retirement readiness remains on track.

For further details and guidance tailored to your personal situation and evolving tax legislation please contact this office.