Key Points
Allowable Distributions
Most TSA distributions take place at or after the employee’s retirement — these are “allowable distributions.” As a general rule, allowable distributions from a TSA may begin as early as age 59½. Distributions prior to age 59½ are considered premature and are subject to the 10% early withdrawal penalty tax, in addition to ordinary income tax, unless a specific exception applies (such as death, disability, or substantially equal periodic payments).
TSA savings are intended for retirement — the law prevents their use as a perpetual tax shelter. Required minimum distributions must begin no later than:
- April 1 of the year following the year the participant turns age 73 (under SECURE Act 2.0, effective 2023), or
- the calendar year in which the participant retires — whichever is later.
For participants born after December 31, 1959, the RMD starting age increases to 75, effective beginning in 2033. The same RMD calculation methods, timing rules, and penalties that apply to traditional IRAs and 401(k) plans apply to TSAs.
Distribution Options
When an employee elects to begin receiving distributions, three general methods are available:
The entire balance in the TSA is distributed in a single payment. Unlike lump-sum distributions from certain other qualified plans, TSA lump-sum distributions do not receive special income tax treatment such as ten-year forward averaging. The full amount must be reported as ordinary income in the year received — unless it is immediately rolled over to an IRA or another TSA.
The employee receives distributions over time based on life expectancy or joint life expectancy (with a spouse or other designated beneficiary). The participant may choose to accelerate payments at any point. IRS life expectancy tables are used to calculate the required annual distribution amounts.
Distributions are made according to the terms of the annuity contract — providing lifetime or joint lifetime income based on actuarial tables. This option is available only when the TSA is funded through an annuity contract with an insurance company.
Taxation of Distributions
When the TSA is funded entirely with pre-tax employee deferrals, employer contributions, and tax-deferred earnings, the taxation of distributions is straightforward: the full amount distributed is taxable as ordinary income in the year received. The participant owes no tax before that point because all contributions escaped taxation when made.
The calculation becomes more complex when a participant has previously been denied the exclusion for part of their TSA contributions — creating a cost basis in the plan. This can happen for several reasons:
- the employee’s salary decreased such that a contribution exceeded the allowable limit,
- the employee changed jobs and lost credit for past service, reducing the deferral limit, or
- a calculation error resulted in an excess contribution.
When an employee deferral is not excluded from income (because it exceeded the limit), the employee must:
- report the excess as ordinary income in the year of the excess contribution, and
- recognize that this amount may be taxed again when distributed from the TSA — unless proper records are maintained.
Cost basis in a TSA refers to amounts the participant has contributed that were already subjected to income tax. It includes:
- nondeductible employee contributions (voluntary after-tax contributions),
- excess deferrals or employer contributions for which the participant has already paid tax,
- life insurance costs reported as taxable income (the “PS 58 costs”), and
- repayment of a policy loan that was previously treated as a taxable distribution when made.
When an employee has a cost basis, part of each distribution represents the tax-free return of those previously taxed amounts. The IRS uses the exclusion ratio to determine what portion of each annuity payment is taxable and what portion is tax-free return of basis.
The employee or beneficiary must maintain permanent records of any excess contributions to a TSA. Without documentation, the IRS will treat all TSA distributions as fully taxable ordinary income — even if the participant actually had a cost basis. With proper records, the cost basis portion is received tax-free upon distribution.
Rollovers and Transfers
As a general rule, distributions from TSA plans may be rolled over tax-free to an IRA or to another TSA. A pre-59½ distribution that is properly rolled over is not treated as a premature distribution and avoids the 10% penalty. The standard 60-day rollover rule applies, and direct trustee-to-trustee transfers avoid withholding entirely.
A participant may also direct the TSA administrator to transfer assets directly to another TSA, including:
- from one insurance company to another,
- from one contract’s cash value to another contract,
- from one employer’s plan to another (upon changing jobs),
- from a personal annuity contract to a TSA, or
- from one custodian or trustee to another (for custodial account TSAs).
The following types of distributions may not be rolled over:
- Required minimum distributions (RMDs),
- Substantially equal periodic payments based on the participant’s life expectancy or joint life expectancy (72(t)/SEPPs), and
- Distributions of excess employer contributions.