Qualified Plan Funding

As we just reviewed, annuities bring a variety of advantages to qualified plans. The types of qualified retirement plans that can use annuities as a funding vehicle for periodic plan contributions include:

• Individual Retirement Annuity (IRA). An IRA is a tax-favored personal retirement savings plan available to individuals younger than 70 1/2 who receive compensation or earned income from personal services. An eligible individual can contribute up to the lesser of $4,000 or 100 percent of earned income to an IRA each year. In addition, the non-working spouse of an eligible individual can own a spousal IRA. In this case, the maximum contribution to both IRAs cannot exceed $8,000.

  While an individual may be eligible to contribute to an IRA, the deductibility of those contributions depends on two circumstances:

1. An individual cannot deduct an IRA contribution if he or she is an active participant in an employer-sponsored qualified retirement plan and has an adjusted gross income (AGI) in excess of specified levels. For 2004, active participants who are married and have MAGI of $65,000 or more ($45,000 or more if single) cannot deduct IRA contributions. For MAGIs between $65,000 and $75,000 ($45,000 and $55,000 if single), the IRA deduction is gradually reduced as MAGI increases. In the case of MAGI below $65,000 for a married active participant ($45,000 if single), the full IRA contribution is deductible.
2. An individual cannot deduct an IRA contribution in the year in which age 70 1/2 is reached, or in succeeding years.

Regardless of whether or not IRA contributions are deductible, all earnings on those contributions grow, tax deferred, until received. Since IRA's were designed as long-term investments for retirement, any withdrawals prior to age 59 1/2 are subject to an IRS early withdrawal penalty of 10 percent as well as income taxes. An individual can select among a wide variety of investment vehicles to accept IRA contributions, including annuities and mutual funds. Life insurance, however, is not a permitted IRA investment.

• 403(b) Tax Sheltered Annuity (TSA). A TSA is a special kind of tax-qualified retirement plan available to the employees of nonprofit organizations (501(C)(3)) organizations and public school systems. TSA contributions are not reported as income and can result from a reduction in an eligible employee's salary or from employer contributions. The maximum annual TSA contribution that can be excluded from gross income depends on its source.

Salary Reduction Plans — Salary reductions to a TSA cannot exceed the lesser of $13,000 or the employee's exclusion allowance each year. The exclusion allowance is a formula that 1) multiplies 20 percent of the employee's includable compensation (salary, vacation pay, sick pay, and disability income, but not deductions made under the salary reduction agreement) times the number of years of service the employee has with the employer, and then 2) subtracts the total amount of previous years' TSA contributions.

For example, let's assume that a college professor with four years of service earns $65,000 per year, has a $10,000 salary reduction agreement, and has a total of $30,000 in TSA contributions made in previous years.

$55,000   Includable Compensation
x    20%   ($65,000 - $10,000)
$11,000
x        4    Years of Service
$44,000
-30,000   Previous TSA Contributions
$14,000   Exclusion Allowance

In this example, the employee's maximum allowable TSA contribution would be limited to $13,000, even though the employee's exclusion allowance is $14,000.

Employer Contribution Plans — Employer contributions to a TSA on behalf of an employee cannot exceed the lesser of 25 percent of compensation or $41,000 (adjusted annually for inflation).

There are also "catch up" provisions available to those employees who have not made maximum TSA contributions in prior years and who have 15 years of service with an eligible organization.

Once an eligible employer and employee establish a salary reduction plan, or the employer agrees to a contribution TSA plan, TSA contributions must then be made directly by the employer into an annuity contract or mutual fund. Those are the only two approved TSA funding vehicles. In both cases, TSA contributions grow, tax deferred.

Back to Top | Next

Ohio National is not affiliated with, nor does it endorse or sponsor, any particular prospecting, marketing or selling system.

22