Helping staff plan for retirement is more than just a great employment perk. It doesn’t just give a church an edge in recruiting; it actually helps churches plan for the future transition of leadership to the next generation. In our prior article on retirement planning, we mentioned that most succession planning failures our firm has seen is due to the lack of planning and funds available to the pastor for retirement. When a pastor feels they are unable to financially sustain retirement, their willingness to participate in succession planning is significantly inhibited. At the end of the day, without adequate retirement funds, the math doesn’t add up and they financially cannot afford to retire. Pastors are often, understandingly so, hesitant to share their financial position with their board of directors or trustees. Fear of being seen in a negative light when it comes to financial prowess can be nerve-wrecking for any individual, especially one leading an organization. But just because someone isn’t prepared for retirement, doesn’t mean they “messed up.”
Pastors face several unique challenges for retirement. One of the most significant issues we routinely encounter is the advice pastors received to opt out of social security. While many today see this as ill-advised, it was the prevailing philosophy and recommendation forty years ago and has still been recommended by some financial planners in recent years. The prevailing argument to support an opt-out was that a pastor would be better served to not pay social security and to take whatever money was retained by the pastor and to immediately designate such funds as retirement savings. Unfortunately, the idea that the “extra savings” would be put into a savings or investment account didn’t usually take into account traditionally low earnings for pastoral staff. The reality that many pastors have not had the luxury to save these funds and instead had to make use of them for common life expenses for their families, as well as the financial recessions that have been experienced in the last decade.
Furthermore, many pastors are unaware that the implications of opting out of social security aren’t just about a monthly check the individual would receive from the federal government during retirement; it also opts a pastor out of Medicare. This leaves many pastors with the option of paying out of pocket for healthcare once they retire or spending down their assets to qualify for Medicaid (for many individuals and married couples, they are only allowed to have $2,000 or $3,000 in assets to qualify for Medicaid, as well as very limited monthly income).
We recommend that new pastors take a thoughtful evaluation of the long-lasting implications of opting out of social security before they take such a significant step. They need to understand two things about opting out of social security: 1) you cannot opt back in for any ministerial work, and 2) you are also opting out of Medicare. New pastors should also be aware that they will be taxed as self-employed and choosing not to opt out of social security will result in an increased tax burden on a quarterly and annual basis. Failure to maintain discipline and timely tax payments will result in federal tax penalties and increased tax liability exposure.
Retirement Planning Mechanisms
While we understand that many churches will not be able to afford adequate retirement planning tools, it is important that retirement planning remain a topic of conversation as everyone continues to age toward a time in their life when earning abilities wane. So, what can a church do to assist its pastors in planning for retirement? There are several mechanisms churches should explore, each one having its own costs and benefits.
(1) Calculated Compensation Raise to Account for FICA Taxes.
The first mechanism is to consider the self-employment status of your ministerial staff and if they have not opted out of social security, consider an additional 7.65% (2023 rate) increase to assist in paying the traditionally employer’s side of FICA. For an annual salary of $50,000, a 7.65% increase would result in an additional payment of $3,825 per year. While taxable, this increase would help offset the FICA responsibility the pastor carries on their own.
(2) 403(b) Retirement Accounts.
The second mechanism is to look at the potential 403b retirement accounts available to the church. If the church is not large enough to administer its own plan, there are several denominational and cross-denominational options for shall churches to participate in. Churches should also consider matching programs to assist in retirement funding of 403b programs. There is a trend for churches to consider 401k plans. While traditionally 401k plans are for for-profit businesses, whereas 403b plans are for nonprofits, we are seeing increased interest in churches using 401k plans. Part of this is due to church board members understanding of 401k plans, they are often more familiar with their own company’s plans and not at all with 403b plans, so they feel safer sticking with what they know. And while 401k plans can offer a wider range of investment options, 403b plans still offer mutual funds and annuities. Also, 403b plans are often cheaper to administer and have lower overhead. Lastly, distributions from a 403b plan can be designated as housing allowance, allowance contributions and distributions to be tax-free. This housing allowance benefit is by far a favorite benefit of the 403b plan.
(3) Rabbi Trust.
The third mechanism is something colloquially known as the “Rabbi Trust,” or as tax professionals may call it, the Non-Qualified Deferred Compensation Plan. This retirement tool is used by many types of 501(c)(3) organizations, including churches. As the name suggests, it was first implemented by a synagogue for their Rabbi. The IRS provided a private letter ruling blessing the arrangement. The Rabbi Trust is something called a “grantor trust” – meaning the funds remain as assets of the grantor (i.e. the church) until certain, specified conditions are met. For example, as part of the retirement package for a senior pastor, a church opens a Rabbi Trust and invests $10,000.00 per year. The senior pastor’s interest is not vested, and the investment account and the funds belong to the church until the senior pastor’s retirement. At that time, the funds are paid out according to a schedule – all at once, or even over a scheduled ten years. Additional conditions can be drafted, such as payout upon the senior pastor reaching a certain age. The money becomes taxable to the recipient upon receipt, and there is no vesting prior to that. There are several reasons why churches would implement a Rabbi Trust; however, there are also definitive legal requirements churches must follow. Often, it is used by a church to catch up a retirement fund when it has been unable to do so in the past, such as is often the case if a church went through a season of financial stress and was unable to provide a pastor with any increases of compensation.
If you think the Rabbi Trust is a mechanism your church would like to utilize, please seek competent legal counsel. Do not attempt to establish a Rabbi Trust on your own. It some situations where the church has tried to create the trust on their own, we have seen where the pastor was liable for taxes on the entire amount without having ever received the retirement funds.
(4) Housing.
Fourth, church boards should have an open and honest conversation with their pastors on the issue of housing. Most individuals use their home to help fund retirement in their final years. However, many pastors live in parsonages. Answering questions like: “How long does that pastor need to live in a parsonage following their retirement?” and “Do they have funds for a down payment?” are critical questions. A pastor should not have to choose between staying in a job too long and homelessness, but we have seen this come up time and time again, especially when the board members are unaware of their pastor’s financial disposition.
(5) Retirement Gifts.
Finally, if your church wants to provide a retirement gift to a pastor before he leaves, the board should seek competent legal counsel prior to providing that gift. The IRS has issued opinions on retirement gifts, but they are not recent, which adds to the complexity of the matter. Nonprofits, including churches, are required to pay reasonable salaries and compensation. Substantial gifts can sometimes violate these rules, opening the pastor and the church board to fines and other penalties by the IRS.
Retirement planning for pastors and any individual is important, but it is just as important for church boards. A church’s successful transition to the next generation is often dependent upon proper planning for the previous generation of leaders. If you have questions about retirement planning for your church’s staff, let us know and we would love the opportunity to discuss those options for your church.
The information provided in this article does not, and is not intended to, constitute legal advice or investment advice; instead, all information, content, and materials available in this article are for general informational purposes only. Information contained in this article may not constitute the most up-to-date legal or other information. This article contains links to other third-party websites. Such links are only for the convenience of the reader, user, or browser; the author does not recommend or endorse the contents of the third-party sites.
Readers of this article should contact their attorney to obtain advice with respect to any particular legal matter.
Anthony & Sparkman, PLLC is a law firm located in both Dallas/Fort Worth and Georgetown, Texas that provides legal counsel to both churches and nonprofits around the world. John Anthony & Michele Sparkman have spent over a decade providing general counsel to churches and nonprofits on issues ranging from incorporations, governance, employment, policies and procedures, taxes, succession planning, real estate development and much more. For more information visit our website at www.thenonprofitteam.com.
