"I know that the IRS does allow for retirement distributions from a 403(b) plan to be at least partially designated as a housing allowance (true, see my Feb. 6, 2007, post and others). But up to this point I have not found if this is available for 403(b)(7) plans. A pastor has a 403(b) plan that he and the church both contribute to. Is there any way that part of the retirement distributions can be designated as a housing allowance? I have talked to [the mutual fund firm] and it will not “code” the Form 1099-R for any housing allowance." (The mutual fund firm will not report a lower taxable amount for a distribution than it reports as the full distribution amount simply because a recipient can provide documentation of a housing allowance designation by his congregation.)
Two issues here...
1) Regardless whether the investments are held in a traditional TSA sold only by insurance companies (as initially described by Congress in 1958 when it established 403(b) plans) or in mutual funds (as modified by Congress in 1974 in IRC section 403(b)(7) to allow for non-annuity investments) a church can designate all or a portion of the distributions as housing allowance. Of course, a minister must comply with other requirements (e.g. must be 59 1/2 years old).
2) In my July 26, 2008, post I stated "the retired minister reports the full distribution on Line 16a (2007 Form 1040) and the taxable amount after allowable housing allowance on Line 16b." This reporting method, however, does have its challenges. The IRS document matching program may/will assume that an error has been made and propose a change in the return. The taxpayer must respond by providing an explanation for the discrepancy. I recommend that a schedule of the minister's housing expenses also be provided. The minister should maintain his documentation in case the Service requests it.