How are contributions to a tax-sheltered annuity treated for tax purposes?

Contributions to a tax-sheltered annuity are treated as not included in the employee’s income at the time of contribution. This means that when an employee contributes to a tax-sheltered annuity, they do not have to pay income tax on those contributions until they begin to take withdrawals from the annuity during retirement. At that point, the amounts received are taxable as ordinary income. This tax deferral is one of the significant benefits of a tax-sheltered annuity, encouraging individuals to save for retirement without immediate tax consequences.

Other potential treatments, such as being fully taxable upon contribution or being deductible from personal income tax, do not accurately reflect the tax advantages associated with these accounts. The focus on tax-exempt status during accumulation and distribution also misrepresents how these annuities function, as taxes are indeed owed upon distribution. Thus, the correct understanding is that the contributions remain untaxed now, with tax implications arising instead when the funds are eventually withdrawn.