The Hidden Power of Your 403(b) Sensible Stewardship

Nazarene Benefits USA sponsors a 403(b) Retirement Savings Plan for U.S.-based ministers to help them save for retirement and receive tax benefits while doing so.

If you have been participating in the 403(b) plan, you’re likely familiar with the advantages of being able to make tax-deferred contributions. Tax-deferred means you can make contributions before any income taxes are taken out, which is also referred to as pre-tax. This tax savings means you have more money to invest and grow.

For example, let’s say you have $100 to invest and you’re in the 12% federal and 5% state income tax brackets. The fact that you can invest in your 403(b) pre-tax means you get to invest the entire $100. If you had to pay taxes first, you would only have $83 to invest.

Being able to invest pre-tax money is a benefit that is available to everyone who participates in a 403(b) plan. However, there’s an additional benefit for pastors that you might be familiar with if you read this column regularly. Pastors are eligible to claim a housing allowance from their church 403(b) plan in retirement. Claiming a housing allowance means you can put money into the retirement plan without paying income taxes and then use those dollars in retirement for qualified housing expenses without paying any income taxes. That’s a double tax benefit that is only available to pastors and only if they save into a churchsponsored retirement plan.

Being able to claim a housing allowance and never pay income taxes on your retirement savings is a lucrative opportunity and a good enough reason for any pastor to prioritize saving into a 403(b) plan over other available options. But what if I told you there are even greater benefits?

Claiming a housing allowance means you can put money into the retirement plan without paying income taxes and then use those dollars in retirement for qualified housing expenses without paying any income taxes.

For pastors who are participating in Social Security, saving into a 403(b) through payroll deductions is one of the smartest financial moves they can make. For every $100 they put into their 403(b) account, they save $15 in taxes. Why? Because 403(b) contributions avoid SECA (Social Security and Medicare) taxes.

The only people who can do this are pastors, and the only accounts it works with are church-sponsored 403(b) plans because of the way pastors are dual status taxpayers. For most employees, Social Security and Medicare taxes are taken out of their pay before it is contributed to their retirement plan. However, pastors are treated as if they are self-employed (SE) and pay those taxes through the SECA system.

With SECA, pastors calculate their Social Security and Medicare taxes on their own on Schedule SE when they file their tax returns. Those calculations are based on the income numbers provided on Form W-2, which doesn’t include 403(b) contributions as taxable income. That means the numbers used to calculate and pay those taxes are after retirement contributions have been taken out. The retirement contributions are never subject to SECA taxes—neither when contributed nor withdrawn from the account.

This may seem like a questionable loophole, but the IRS is fully aware of it and doesn’t seem to see anything wrong with it.

Let’s take a look at what that means with real numbers. SECA taxes are about 15%, and we’ll use our assumed 12% federal and 5% state tax rates from before. If you had to pay all of those taxes on your $100, you would only have $68 left to invest. If you’re a pastor, you don’t pay any of those taxes, so you still have the full $100 to invest.

It’s almost as if the government is providing a 47% matching contribution (the additional $32 you have to invest is 47% of $68). I don’t know about your church, but I’ve never seen an employer that provides a 47% match, so this is a pretty rare opportunity!

While 403(b) plans offer the benefit of tax deferral to all participants, clergy have the unique ability to claim 403(b) funds as a housing allowance in retirement and also avoid SECA taxes on their contributions. Are you taking advantage of this opportunity?

Amy Artiga is a Certified Financial Planner (CFP), a Certified Kingdom Advisor™, and author of the clergy personal finance blog PastorsWallet.com. Send questions for Amy to benefits@nazarene.org.

Note: This material is provided for informational purposes only. The author and NBUSA do not provide tax, legal, or accounting advice.