Serving, preaching, discipling—whether ordained, commissioned, or licensed—pastors faithfully shepherd the flock. We thank pastors for their wholehearted dedication. In the midst of ministry, finding time to explore the unique retirement strategies can be a challenge. One of the most powerful, and often overlooked, tools is the 403(b) retirement plan. Through its integration with the housing allowance, the 403(b) is a hidden gem for pastors if used wisely.
What is a 403(b)
A 403(b) is a type of retirement investment account that is common across government, schools, and nonprofits. Named after the section of the IRS code that created it, a 403(b) allows employees to invest a portion of their salary in a tax advantaged way. There are two main types of contributions:
- Traditional 403(b): Contributions are made pre-tax, reducing your taxable income now. Taxes are generally paid when funds are withdrawn in retirement.
- Roth 403(b): Contributions are made after-tax, but withdrawals in retirement are generally tax-free.
While Roth contributions have their benefits, pastors specifically may find advantages in the traditional 403(b).
The Housing Allowance Advantage
One of the most powerful features of a 403(b) for pastors is its integration with the ministerial housing allowance.This allowance saves pastors thousands of dollars annually by excluding a portion of their income from federal income tax. While actively serving, churches can designate a portion of a pastor’s income as a housing allowance. This amount—up to the lesser of the designated amount, actual housing expenses, or the fair rental value of their home—can be excluded from federal income tax. In retirement, the same rules exist, but the pastor is no longer receiving a housing allowance through their salary. In that case, a pastor can use funds saved during their ministerial years that are designated as housing allowance, such as from their 403(b).
Imagine this scenario:
- A pastor contributes to a traditional 403(b) during their ministry years and receives a tax deduction.
- In retirement, they begin taking distributions from the 403(b).
- These distributions are designated and claimed as housing allowance, meaning:
- No federal income tax was paid on the contributions.
- No federal income tax is due on the distributions.
This creates a rare and powerful opportunity: tax-free in, tax-free out.
Important Considerations
Before celebrating, there are a few housekeeping items to consider:
1. Proper designation: The plan should allow the church to officially designate distributions as housing allowance. Not all 403(b)s have this feature, so consider administrative steps to make this happen.
2. Caution rolling into an IRA: Many pastors consider rolling their 403(b) into a Traditional IRA at retirement. However, this may permanently eliminate the ability to claim housing allowance on those funds. This cannot be emphasized enough. Always consult a tax professional before making this move.
As with all things IRS, there are exceptions—and exceptions to the exceptions. Always consult with a qualified tax advisor and financial planner to determine how these rules apply in your unique situation.
Final Thoughts
A pastor’s 403(b), while often viewed as a typical retirement tool, is no typical retirement tool. A pastor requires in-depth financial planning, tax planning, and someone familiar with particular ministerial rules. At Covenant, we want to serve those who serve us. We recognize the unique landscape pastors face, from seminary loans to housing allowance to the weight of ministry itself. Let us walk alongside you. Call us at 586-739-3550 to schedule an initial no-cost consultation. It’s time to build out your financial plan—with a trusted advisor by your side.