How Are Contributions to a Tax-Sheltered Annuity Treated?

A Tax-Sheltered Annuity, more commonly known as a 403(b) plan, is a retirement savings plan available to employees of specific organizations. These include public schools, colleges, universities, and various non-profit entities recognized under section 501 of the Internal Revenue Code, such as religious institutions and charitable organizations. The tax treatment of contributions is a feature of these plans that influences an employee’s current income tax liability and how the funds will be taxed in the future.

Tax Treatment of Employee Contributions

The tax implications of an employee’s contributions to a 403(b) plan depend on the type of contribution selected: traditional pre-tax or Roth. When an employee elects to make traditional contributions, the funds are deducted from their gross pay before federal and state income taxes are calculated. This reduces the employee’s taxable income for the year, providing an immediate tax benefit. The contributions and any investment earnings grow on a tax-deferred basis, and income tax is only paid when the funds are withdrawn, typically during retirement.

For example, an employee earning $60,000 who contributes $5,000 to a traditional 403(b) will only be taxed on $55,000 of income for that year. The trade-off for this upfront tax savings is that all withdrawals in retirement, including both the original contributions and all accumulated earnings, will be taxed as ordinary income. This approach is often favored by those who anticipate being in a lower tax bracket during their retirement years.

Alternatively, a 403(b) plan may permit Roth contributions, which reverses the tax treatment. Roth contributions are made with after-tax dollars, so there is no immediate reduction in the employee’s taxable income for the contribution year. The primary advantage of this method is realized in retirement.

Provided certain conditions are met, qualified distributions from a Roth 403(b) are completely tax-free. This includes the withdrawal of the original contributions and all of the investment earnings. An employee earning $60,000 who contributes $5,000 to a Roth 403(b) is still taxed on the full $60,000 of income that year. The benefit is that they can withdraw the entire account balance in retirement without paying federal or state income tax on a qualified distribution.

Annual Contribution Limits

The Internal Revenue Service (IRS) sets specific limits on the amount an employee can contribute to their 403(b) plan each year. For 2025, the general limit for employee elective deferrals is $23,500. This cap applies to the total amount an employee can contribute from their salary, whether to a traditional pre-tax account, a Roth account, or a combination of both.

To help individuals nearing retirement boost their savings, the tax code allows for catch-up contributions. Employees who are age 50 or over can contribute an additional amount beyond the standard elective deferral limit. For 2025, this age 50+ catch-up contribution is $7,500.

Beginning in 2025, a new provision allows for an even higher catch-up amount for employees aged 60, 61, 62, and 63. For this specific age group, the catch-up contribution is $11,250, which replaces the standard catch-up.

A unique feature available only to 403(b) plan participants is a separate catch-up provision known as the 15-year rule. An employee who has completed at least 15 years of service with their current employer may be eligible. Eligible employers include:

• Educational organizations
• Hospitals
• Home health service agencies
• Health and welfare service agencies
• Churches, or conventions or associations of churches

This special catch-up allows for an additional contribution of up to $3,000 per year, with a lifetime maximum of $15,000 for this specific provision.

Separate from the limits on employee salary deferrals is the overall contribution limit. This is a broader cap that includes all sources of contributions to the account for a given year. This total encompasses the employee’s elective deferrals, any employer contributions, and any after-tax contributions. For 2025, this overall limit is the lesser of 100% of the employee’s compensation or $70,000.

Tax Treatment of Employer Contributions

Many organizations that offer 403(b) plans also contribute to their employees’ accounts. When an employer makes a contribution to an employee’s 403(b) plan, that amount is not included in the employee’s gross income for the year. This means the employee does not pay current income tax on the funds provided by the employer.

Regardless of whether an employee chooses to make traditional pre-tax or Roth contributions with their own money, all employer contributions are universally treated as pre-tax. The employer-contributed funds, along with all the investment earnings they generate, will be fully taxable as ordinary income upon distribution. This holds true even if the employee’s own contributions are to a Roth account.

These employer amounts do not count against the employee’s annual elective deferral limit ($23,500 for 2025, plus catch-ups). However, they are included in the overall annual additions limit. For example, if an employee contributes $23,500 and their employer adds $5,000, the total addition of $28,500 is well within the $70,000 overall limit for 2025.

Reporting Contributions on Your W-2

Your employer reports your employee contributions in Box 12 of the W-2. This box uses specific codes to identify the type of contribution made throughout the year.

The code E is used to designate all employee contributions made to a 403(b) plan on a pre-tax basis. If you have made contributions to a Roth 403(b), these will be identified in Box 12 with the code BB. It is possible for an employee to have both codes listed if they contributed to both traditional and Roth accounts.

The type of contribution directly affects the amount reported in Box 1, which shows your “Wages, tips, other compensation.” Any pre-tax contributions, identified by code E in Box 12, have already been subtracted from your total pay before arriving at the figure in Box 1. Conversely, Roth contributions (code BB) are not subtracted, so the wage amount in Box 1 includes the money you contributed to your Roth 403(b).