Chapter 5 — Investments

In the past, TSA plan savings were used solely to purchase annuity contracts from life insurance companies. The range of permissible investments for 403(b) plans has expanded significantly, and today banks, savings associations, credit unions, and brokerage firms participate in the TSA market as custodians and trustees.

A custodial account is established through a written custodial agreement between the employer and the custodian. The law specifically authorizes the use of custodial accounts; a trust agreement serves the same legal function and is also permitted. The duties of a trustee and custodian are essentially the same under the law.

TSA savings may be invested across a wide range of options, including:

• mutual funds,
• stocks,
• bonds,
• certificates of deposit (CDs),
• money market funds,
• government securities,
• treasury bills, and
• annuity contracts.

The best investment choice depends on the participant’s investment preferences, the employer’s guidelines, the participant’s risk tolerance, and their retirement income goals.

TSA participants are well-advised to invest in assets that produce ordinary income — money market funds, CDs, bonds, and income-producing stocks or mutual funds — rather than assets primarily oriented toward producing long-term capital gains.

The reason: capital gain assets produce returns that are ordinarily tax-favored (lower rates). However, since TSA earnings already grow tax-deferred inside the plan, the specific tax advantage of capital gains is wasted — the gains simply accumulate untaxed until distribution. When TSA savings are eventually distributed, all amounts are taxed as ordinary income regardless of the underlying investment character. Additionally, any capital losses inside the TSA also receive no special tax treatment — losses cannot be deducted. This makes ordinary income-producing investments (bonds, money market funds, CDs) a more efficient match for the TSA’s tax structure.

When TSA savings are used to purchase an annuity contract, the plan may use either an individual annuity contract or a group annuity contract.

Under the individual funding method, separate annuity contracts are issued to each TSA participant by an insurance company. Typically these are retirement annuity contracts that provide:

• Monthly retirement income for life — regardless of how long the participant lives, income continues.
• A death benefit equal to the return of premiums paid or the cash value, whichever is greater.
• No evidence of insurability required — the participant does not have to qualify medically for the annuity.

Individual retirement annuities are available in various forms:

• Single-premium deferred annuities — funded with one lump-sum premium, accumulate tax-deferred until annuitization.
• Level-premium deferred annuities — funded with regular periodic premiums over time.
• Immediate annuities — begin distributing income immediately upon purchase.
• Variable annuities — the insurance company guarantees a fixed (minimum) interest rate plus a variable rate tied to the investment performance of the underlying fund supporting the contract.

The administrative complexity and cost of issuing separate individual contracts for every participant led to the development of the group funding method. Under this approach:

• A single group annuity contract is issued to the employer, rather than separate contracts to each participant.
• Individual certificates are issued to each plan participant confirming their coverage and benefit amount under the group contract.
• Contributions may be used to purchase single-premium or level-premium fixed or variable annuities under the group contract.

Group contracts significantly reduce the per-participant administrative burden and are the most common annuity structure for employer-sponsored TSA plans with many participants.

A wraparound annuity is a hybrid product combining a variable annuity contract with mutual fund investments. Under this structure:

• The insurance company issues a variable annuity contract to each participant.
• However, contributions are not deposited into separate insurance company accounts. Instead, the money is used to purchase mutual fund shares — which may be administered by the insurance company or by an independent investment company.
• At distribution time, the insurance company redeems the mutual fund shares and distributes the proceeds to the participant or beneficiary.

The wraparound annuity gives participants access to mutual fund investment options while maintaining the annuity contract framework required for TSA treatment under §403(b).