First, let's discuss the options; then we'll consider how the church can get involved.
The best retirement plan option for each minister depends on his objectives and his current tax situation. The three most common retirement plan options used by ministers include:
(a) IRC 403(b) plans (also called Tax Sheltered Annuities (TSAs)),
(b) Traditional Individual Retirement Accounts (IRAs), and
(c) Roth IRAs.
Ministers often select 403(b) plans when they want to maximize their eligible contributions, or to reduce their self-employment tax burden. For the year 2008, a minister may elect to have his employer withhold ("elective deferral") up to $15,500 of his compensation and contribute it, instead, to his 403(b) qualified investment account. Many ministers are eligible to increase this amount by another $5,000 to catch-up for earlier years' smaller deferrals (IRS Publication 571). In addition, unlike other retirement plan choices (Traditional and Roth IRAs, and for-profit company 401(k) plans), a minister is not subject to the 15.3 percent federal self-employment tax on amounts deferred into 403(b) accounts (IRS Revenue Rulings 68-395 and 78-6). This is also true of any amount that his employer contributes over-and-above the minister's own elective deferral.
The situations for which Traditional IRAs are the best choice for a minister's retirement plan are less frequent, especially since the establishment of Roth IRAs beginning with the 1998 tax year. For the year 2008, a minister and his wife may each contribute up to $5,000 to qualified IRA accounts; an additional $1,000 each may be contributed if they are 50 years of age (IRS Publication 590). A minister who has opted out of the social security system but is still looking for additional income tax deductions may find the Traditional IRA his best choice. These contributions can often be made even if the minister participates in a 403(b). However, he may not be able to deduct his full Traditional IRA contribution. For this reason and others, many ministers choose Roth IRA's instead of Traditional IRAs.
Roth IRAs enable ministers to make the same amount of contributions as do Traditional IRAs but without receiving an income tax deduction. For many ministers, especially those with young families and ample housing allowances, additional tax write-offs are not needed. Unlike Traditional IRAs, not only will future retirement (age 59½ or later) distributions of their current Roth IRA contributions be untaxed, the earnings distributed from the Roth IRA will not be taxed. Further, pre-retirement distributions may be made without penalty for:
(a) Medical expenses (and health insurance premiums for the unemployed).*
(b) Qualified higher education expenses.*
(c) New home purchase costs for taxpayers who have not owned a personal residence for at least two years ("first time homebuyers").
*Also available for some Traditional IRA distributions.
Now, how can the church get involved? The best way for a church to be assured that funds set aside for contribution to its minister's retirement are deposited into qualified accounts is to deliver its payments directly to the financial institution entrusted with the pastor's investments. Unless the church wishes to exceed the limits mentioned above (from $5,000/$6,000 for IRAs to $15,500/$20,500 for 403(b) plans) a check written by the church to the financial institution will work fine. Reporting on the pastor's Form W-2 at year-end will depend on the plan chosen. The options:
(a) IRC 403(b) plan—treat the payment as if it was additional compensation that was immediately elected by the pastor for withholding as an "elective deferral." The amount is excluded from his taxable income and reported in Box 12 (Code letter "E" is also entered). This amount can be increased by any additional amounts the minister elects to be withheld from his own cash compensation for deferral into the 403(b) plan.
(b) Traditional Individual Retirement Accounts (IRAs)—treat the payment as additional compensation reported as taxable income in Box 1. The pastor will take his IRA deduction on his personal return.
(c) Roth IRAs—treat the payment as additional compensation reported as taxable income in Box 1.