How Are Contributions to a Tax-Sheltered Annuity Taxed?

Contributions to a tax-sheltered annuity (a 403(b) plan) are taxed one of three ways depending on who puts the money in and which account bucket the employee chooses. Employee pre-tax contributions are excluded from your taxable wages the year you make them and taxed as ordinary income when you withdraw them. Roth employee contributions are taxed at your current rate on the way in and come out tax-free if the distribution is qualified. Employer contributions, whether matching or non-elective, are not taxed when deposited and are taxed only when distributed. Investment earnings inside the account grow without current tax under all three treatments.

Pre-Tax Employee Contributions

Pre-tax is the default for most 403(b) participants. You sign a salary reduction agreement, and your employer diverts part of each paycheck into the plan before calculating federal income tax withholding. The money never appears as taxable wages on your W-2.

The tax savings happen paycheck by paycheck, not as a year-end refund. If you earn $70,000 and defer $10,000, W-2 Box 1 (taxable wages) shows $60,000. The deferred amount is reported separately in Box 12 with Code E.¹

One detail that surprises people: the exclusion applies only to income taxes. Pre-tax 403(b) contributions remain subject to Social Security and Medicare (FICA) taxes, so payroll tax is calculated on your full salary.² That also means the contributions still count toward your Social Security earnings record.

Contributions and investment earnings compound with no current tax. When you eventually take distributions in retirement, the entire withdrawal counts as ordinary income for the year you receive it. Original contributions and decades of accumulated earnings are taxed together at whatever bracket you land in. The bet you make with pre-tax deferral is that your retirement rate will be lower than your working-years rate.

Roth Employee Contributions

Roth 403(b) contributions flip the timing. You pay income tax on the money now, and in exchange qualified withdrawals in retirement are completely tax-free. Your employer does not reduce your taxable wages for a Roth deferral, so W-2 Box 1 reflects your full salary including the Roth amount. The Roth deferral appears in Box 12 with Code BB.¹

The tax-free treatment at withdrawal is not automatic. A distribution is qualified only if two conditions are met. First, at least five years must have passed since January 1 of the year you made your first Roth 403(b) contribution. Second, you must be at least 59½, permanently disabled, or deceased (with the balance passing to your beneficiary). When both are satisfied, you owe zero federal income tax on everything that comes out, including all investment earnings.

Take money out before those conditions are met and the distribution is non-qualified. Your original contributions come out tax-free because you already paid tax on them, but the earnings portion is taxed as ordinary income and may trigger a 10% early withdrawal penalty.

Roth makes the most sense if you expect a higher tax bracket in retirement than you have today. That’s often true for younger employees early in their careers, participants anticipating pension income on top of their 403(b), or anyone who thinks tax rates will rise. You can also split your deferrals between pre-tax and Roth to hedge.

Employer Contributions

Employer contributions to a 403(b), whether matching or non-elective, follow the same deferral model as employee pre-tax contributions. The amounts are not included in your taxable income when deposited, and they grow tax-deferred until withdrawal.³ Unlike employee deferrals, employer contributions are also exempt from FICA entirely, so neither you nor your employer pays Social Security or Medicare tax on those amounts.

Employer contributions do not appear in W-2 Box 12 with a dedicated code the way employee deferrals do. Employers may optionally report them in Box 14, labeled “Other,” but they are not required to.⁴

Vesting affects when the money is actually yours. If your plan uses a vesting schedule, you earn ownership of employer contributions gradually over years of service. Unvested amounts you forfeit at separation are never taxed because you never receive them. Vested amounts follow the pre-tax rule: taxed as ordinary income when distributed.

2026 Dollar Limits on Tax-Sheltered Contributions

The tax treatment described above only applies up to annual dollar limits. Exceeding them creates real tax problems, so the numbers are worth tracking carefully.

Elective Deferral Limit

The basic cap on employee contributions (pre-tax and Roth combined) is $24,500 for 2026. It applies per person, not per plan. If you contribute to both a 403(b) and a 401(k) with different employers, your combined elective deferrals across those plans cannot exceed $24,500.⁵ Governmental 457(b) plans have a separate limit and do not count toward this cap.

Catch-Up Contributions

Three catch-ups can push your total above the base limit.

Age 50+ catch-up. If you turn 50 or older by December 31, 2026, you can defer an additional $8,000, for a total of $32,500.⁵

Age 60–63 “super” catch-up. Under SECURE 2.0, participants who are 60, 61, 62, or 63 at year-end can contribute up to $11,250 in catch-up contributions instead of the standard $8,000, for a total of $35,750.⁵

15-year service catch-up. If you have worked for the same qualifying 403(b) employer for at least 15 years, you may defer an additional amount up to $3,000 per year, subject to a lifetime cap of $15,000. Eligible employers include public school systems, hospitals, home health service agencies, health and welfare service agencies, and churches. The actual amount also depends on your average past contributions, so it is not always the full $3,000.⁶

When you qualify for both the 15-year service catch-up and an age-based catch-up in the same year, the 15-year amount is applied first.⁷

Overall Annual Additions Limit

A separate, higher ceiling under Section 415(c) caps the combined total of employee deferrals, employer matching contributions, and employer non-elective contributions at $72,000 for 2026.⁵ Age-based catch-up contributions are excluded from this calculation, so the $8,000 or $11,250 catch-up sits on top of the $72,000.⁸ Your employer is responsible for monitoring this limit and issuing correct W-2s.

What Happens If You Over-Contribute

Exceeding the $24,500 elective deferral limit is one of the costliest mistakes you can make with a 403(b). The excess amount is taxable income in the year you contributed it, whether it was designated pre-tax or Roth. To fix the problem, the plan must distribute the excess deferral and any earnings it generated by April 15 of the following year.⁹

If that April 15 deadline passes with the excess still sitting in the plan, you face double taxation. You already owed tax on the excess for the contribution year, and you will owe tax again when the money eventually comes out as a distribution. The IRS does not forgive one because you paid the other. People who contribute to multiple employer plans get caught most often here: each employer tracks only its own plan, so nothing flags the combined overage until you file your return.

Mandatory Roth Catch-Up for Higher Earners

One rule ahead is worth knowing when you decide between pre-tax and Roth for catch-up contributions. Beginning in 2027, the SECURE 2.0 Act requires that catch-up contributions made by higher-income participants go into a Roth account. If your FICA wages from the employer sponsoring the plan exceeded the inflation-adjusted threshold (currently $145,000, indexed annually) in the prior calendar year, all of your catch-up contributions must be designated Roth.¹⁰ Pre-tax catch-ups will no longer be an option for affected employees.

Plans can adopt this rule earlier using a “reasonable, good faith interpretation” of the statute, so some employers may already require Roth catch-ups in 2026.¹⁰ There is a practical wrinkle: if your 403(b) plan does not offer a Roth option at all, affected employees simply cannot make catch-up contributions. Ask your plan administrator whether the plan has adopted a Roth feature before the deadline reaches you.

1
Internal Revenue Service. 2026 General Instructions for Forms W-2 and W-3
2
Internal Revenue Service. Retirement Plan FAQs Regarding Contributions
3
Office of the Law Revision Counsel. 26 US Code 403 – Taxation of Employee Annuities
4
Internal Revenue Service. Publication 571 – Tax-Sheltered Annuity Plans (403(b) Plans)
5
Internal Revenue Service. Retirement Topics – 403(b) Contribution Limits
6
Internal Revenue Service. 403(b) Plan Fix-It Guide – 15-Year Service Catch-up
7
Internal Revenue Service. 403(b) Plans – Catch-up Contributions
8
Internal Revenue Service. 403(b) Plan Fix-It Guide – Section 415(c) Limits
9
Internal Revenue Service. 403(b) Plan Fix-It Guide
10
Internal Revenue Service. Treasury, IRS Issue Final Regulations on New Roth Catch-up Rule