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A tax sheltered annuity is any annuity that allows an employee to contribute money to his or her retirement using pretax dollars. This works much the same way as a 401k, whereby your income tax burden can be reduced by putting money into an approved retirement fund.
Simplified Tax Sheltered Annuity Example
Let’s say you make $1,000 per month working a part time job, and receive no benefits whatsoever and you live in a state with no payroll tax. Your monthly paychecks will look like this:
Gross: $1,000
Federal Withholding: $51.67
Social Security: $42.00
Medicare: $14.50
Net Monthly Pay: $891.83
Now let’s say you can afford to put away 10% of your gross pay into your retirement fund and you opt for a tax sheltered annuity:
Gross Pay: $1,000
Retirement: $100
Federal Withholding: $41.67
Social Security: $42.00
Medicare: $14.50
Net Monthly Pay: $801.83
As you can see, it cost you $90 to put $100 into your retirement fund. Obviously, when using real numbers the savings are more dramatic and this is especially true if your employer matches your contributions.
Real World Tax Sheltered Annuity Example:
In this example, let’s say you make $50,000 per year and you are ten years away from retirement. You still live in a state without payroll taxes, but now your employer matches your contributions up to 10%.
No Contributions
Gross Pay: $4,166.67
Federal Withholding: $597.92
Social Security: $175
Medicare: $60.42
Net Pay: $3,333.33
Take Home Pay over 10 Years: $399,999.60
Retirement Nest Egg: $0
Total: $399,999.60
Full 10% Contribution
Monthly Gross Pay: $4,166.67
Federal Withholding: $493.75
Social Security: $175.00
Medicare: $60.42
Retirement: $416.67
Retirement Match: $416.67
Total Retirement: $833.34
Net Pay: $3,020.83
Take Home Pay over 10 Years: $362,499.60
Retirement Nest Egg: $100,000.80
Retirement Nest Egg (Including 5% annual interest) $151,323.23
Total: $462,500.40
Total With Interest: $513,822.83
As you can see your tax sheltered annuity cost you $312.50 per month or $37,500 over ten years and your return was $151,323.23. In other words, for every $312.50 you put in, you will get out $948.53. Just to drive the point home, you made an additional $636.03 per month over the 10 year period.
The number one reason people don’t contribute to their 401k, 301b, or tax sheltered annuity is they feel they cannot afford it. However, as you can see the cost to you each month is only a fraction of the amount you gain over the long run. Thus, no matter what your financial situation, you should be able to find the money to invest in your future and to secure your retirement. The best advice you can ever possibly give young people to start their retirement plan immediately and never look back.
