Rhode Island Life Insurance Practice Exam

Which of the following statements about a Tax Sheltered Annuity (TSA) is FALSE?

1. Income derived from the TSA is received income tax-free

2. Contributions to a TSA are tax-deductible

3. Distributions from a TSA are subject to income tax

4. Withdrawals from a TSA incur early withdrawal penalties

The correct answer is: Income derived from the TSA is received income tax-free

The statement that income derived from the TSA is received income tax-free is false because income generated within a Tax Sheltered Annuity (TSA), such as interest, dividends, and capital gains, is generally not subject to income tax while it remains in the annuity. However, this income is taxable when it is withdrawn or distributed from the annuity, which contradicts the claim that it is received income tax-free. In contrast, contributions to a TSA are indeed tax-deductible at the time they are made, allowing individuals to reduce their taxable income. Distributions taken from a TSA are subject to income tax, meaning recipients must pay taxes on the amounts they withdraw. Additionally, if an individual takes a withdrawal before reaching a certain age (commonly 59½), they may incur early withdrawal penalties, which further emphasizes the tax implications associated with accessing funds prior to retirement age. These aspects highlight the importance of understanding the tax treatment of both contributions and withdrawals in the context of TSAs for effective financial planning.