July 15, 2010

Switch to Roth IRA from 403(b) Church Retirement Plan

Question:

A church is currently contributing $6,000 per year to an Internal Revenue Code section 403(b) retirement plan for its pastor. He wants the church to stop putting that money into the 403(b) and start putting it into Roth IRAs for himself and his wife. Can the church pay for Roths for himself and his wife even if the wife is not an employee of the church? This benefits the pastor in that he sets aside tax-free income when he retires, but of course, he loses the tax deferment of the 403(b). Are there any other negatives for the pastor in making this move?

Answer:

Since standard Roth IRA plans are not employer plans, the arrangement discussed above will be treated as if the church had given the $6,000 as additional compensation to the pastor and he subsequently invested the funds into Roth IRAs for he and his wife. The church will simply facilitate his personal investment choices. The $6,000 would be reported as taxable compensation in Box 1 of his Form W-2 and no longer excluded from tax (nor listed as an elective deferred in Box 12a).

For ministers who have not opted out of self-employment tax, they lose not only the reduction of taxable income enjoyed by contributors to 403(b) plans, they no longer may exclude the contribution from SE income on Schedule SE. In effect, the change costs these ministers 15.3 percent of their retirement plan contributions.

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