WHAT SHOULD YOU DO TO PREPARE FOR RETIREMENT?
By: Michael Mudry
One of the realities hardest to pound into a minister’s mind is the actuarial fact that one day he will arrive at retirement age. Then what? Without a retirement plan, a clergyman and his wife may come to face the foreboding prospect of a meager existence in their declining years. But if adequate provision has been made, the prospect of those final years glows bright with the promise of a well-deserved rest, free from financial anxieties.
Most denominations offer pension plans. The boards of these plans strive to attract participation by all their ministers and churches. But most fall short (one board boasts one billion dollars in assets, yet only about 50 percent of that denomination’s ministers are participating in that retirement program).
And then there are the men and women who serve nondenominational churches. For them to have retirement plans, they must act on their own initiative to set aside funds during their years of active ministry.
When ministers retire, their standards of living during retirement compared to those just prior to retirement will depend to a large extent on the degree to which they (and their employers) have set aside funds for that purpose during their years of active service. Unfortunately, it is too easy to focus during active service on immediate financial needs and to defer the financial commitment necessary to accumulate adequate funds for retirement purposes. The consequences of such deferral are frequently that a minister no longer has enough time remaining to accumulate sufficient funds to make adequate retirement provision.
Therefore, it is essential that, early in their careers, ministers obtain sound financial guidance which recognizes not only their immediate financial needs, but also their retirement responsibilities to themselves and their spouses.
Retirement Income Goals
What is a goal toward which ministers should direct their retirement financial planning? Based on various studies made over the years and recognizing the typical level of ministerial salaries, it is estimated that an initial annual gross retirement income of about 65 to 70 percent of the annual gross income just prior to retirement would provide a single minister with a standard of living reasonably commensurate with that which existed just prior to retirement, while 70 to 75 percent is more appropriate for a married minister. These percentages take into account a number of factors that reduce outgo during retirement as compared to pre-retirement years, such as double exemptions for tax purposes, elimination of Social Security taxes, the tax-free portion of Social Security benefits and a decreased need for savings.
Furthermore, the gross pre-retirement income used in developing these percentages should take into account the value of parsonage or housing allowance so as to be more comparable to industry, where the gross income received by an individual must provide for housing. Thus, higher percentages would be needed if the retirement income goal were to be measured against the pre-retirement income excluding the value of housing.
Obviously, it is not possible for any generalization to be universally applicable. Thus, the percentage needed could vary under differing circumstances, depending on such matters as salary level, health, type of housing, etc. However, the 65 to 70 percent for single ministers and 70 to 75 percent for married ministers can be considered as rough guides.
How are these goals to be attained? While there are a number of investment vehicles available for setting aside funds for retirement years, many pension planners classify them as being in three categories-much like a three-legged stool which requires that all three legs be sturdy enough to support the total post-retirement needs of an individual and spouse. The three legs are Social Security, private pension plans of employers and personal savings of the individual.
The degree to which each of these categories of retirement income is applicable would not be the same for all ministers, but would depend on individual circumstances. For example, in some denominations, Social Security plus the benefit provided from employer contributions to the pension plan of the denomination serve to meet the goals by themselves, with little or no need for additional income from personal savings. Nevertheless, it is generally considered that, in order for retirement income to be adequate, it be provided from all three categories of advance financing.
Since most ministers are covered under Social Security, it is normally the first item of retirement income that is taken into account in pension planning. Even though ministers are not usually legally considered self-employed, the pay Social Security taxes under the Self-Employment Contributions Act (SECA) as if they were self-employed.
Accordingly, the responsibility for the payment of the entire tax falls on the ministers. As the result of Social Security amendments which became effective January 1, 1984, contributions required under SECA have been raised considerably-putting an increased financial burden on ministers.
Many churches assist their ministers by reimbursing them for at least one-half their contributions, in order to place them in a position somewhat comparable to that of the typical employee who pays only one-half the Social Security tax, with the employer paying the other half. This is complicated somewhat in church circles because it was possible in the past for lay employees to be exempt from Social Security. However, effective January 1, 1984, lay employees must be covered by Social Security, so the employer must pay the employer portion of the applicable tax related to the wages of such employees. This creates an added cost for some churches, which might affect their willingness also to reimburse the minister for one-half of his or her SECA taxes.
The Social Security pension payable to a single minister who retires at age 65 tends to be about 25 to 40 percent of salary at retirement, with the higher percentages applicable at the lower salary levels. For married ministers, the Social Security pension (including the spouse’s pension) usually ranges between 35 and 60 percent of the minister’s salary at retirement, again depending on salary level, and also on the age of the spouse at the time the spouse benefit commences.
Of course, in order to receive a Social Security benefit, a minister must elect to participate in the program. Some ministers do not, since they have the right to exempt themselves from Social Security taxes. Those ministers who do exempt themselves must rely on the other two legs of the retirement income stool. It appears that ministers are increasingly choosing exemption, so a review of the exemption requirements seems appropriate here.
The act allows a minister to be exempt from Social Security only if he or she is opposed, either conscientiously or due to religious principles, to the acceptance of any public insurance covering death, disability, old age, retirement or medical benefits. However, regulations make it clear that the conscientious opposition must be based on the minister’s religious beliefs rather than simply his or her general conscience; and opposition due to religious principles must reflect the explicit discipline of the minister’s denomination. Thus, the exemption can really be based only on religious considerations.
Since very few denominations take a stand opposing Social Security, it is likely that some ministers filing for exemption are not doing so for truly legal reasons, but for other reasons, such as economic considerations, that are not valid. A minister who is considering filing for an exemption should examine his or her reasons thoroughly and not attempt for invalid reasons to evade the law that applies to the rest of the population.
Private Pension Plans
The second leg that provides the basis of retirement security is provided by contributions by employers to private pension plans. Although the word “employers” may be questionable in certain circumstances, I shall employ that term for the purposes of simplicity.
It is frequently argued that, when an employer contributes to a private pension plan on behalf of a minister, the contributions are really being made by the minister. This position reflects the premise that there is a total compensation package which the employer is willing to finance, so that the minister must accept a smaller cash salary if a portion of the total is to be paid by the employer into a pension plan. Since the total amount of the package could have been paid in cash, the pension contribution really represents the minister’s contribution rather than an employer contribution really represents the minister’s contribution.
Arguments can be made for and against this position. The degree of validity of any argument would be affected by the extent to which the denomination enforces a requirement for the employer to make pension contributions on behalf of a minister as part of the minister’s call. I shall refer to a contribution made by an employer as being an employer contribution, regardless of any questions as to its real source.
What investment vehicles for pension purposes are available for employer contributions? One of the first possibilities which should be considered is the pension plan operated by the denomination (if in fact such a plan exists). Many denominations have pension boards whose responsibilities include the establishment of a plan under which retirement benefits are payable. These plans may or may not require contributions by the minister in addition to those paid by the employer, although usually the employer is allowed to pay the contributions of the minister required. The plans may also pay death, disability and other benefits, or such benefits may be provided through the pension boards under separate plans.
The pension plans are operated under Section 401(a), 403(a) or 403(b) of the Internal Revenue Code in order to obtain the tax advantages available thereunder.
The plans are designated either as defined benefit plans or defined contribution plans. Under the former, the amount of benefit is determined by a formula contained in the plan (such as an annual pension of 1% percent of the total salaries on which contributions have been paid to the plan over the years).
Under a defined contribution plan, though, the contributions are accumulated in much the same manner as in a savings account, with the balance at retirement being converted into a lifetime pension.
The members of the boards which operate these denominational pension plans are usually elected by the assemblies, meetings, conferences, etc., of the denomination and normally include ministers and lay members of the denomination. The board members are selected carefully so as to provide expertise in various aspects of the operations of the plans, including legal, financial and actuarial.
The board members receive no pay for their service as members, but serve solely in the interests of plan participants.
Because of the voluntary service of board members, the absence of commissions and taxes, and the economies of group operations, the denominational plans offer the potential for better results than if the contributions were paid into an individual plan established for the minister. Therefore, every minister (and employer of a minister) should, as a first step, contact the pension board of the denomination before beginning to make contributions for pension purposes elsewhere.
In addition to required contributions to the plan, the pension boards also frequently accept additional contributions on behalf of an employee. Such additional contributions are generally made on a tax-deferred basis under Section 403(b) of the Internal Revenue Code. This section of the code is also referred to as being for tax-deferred annuities, tax-sheltered annuities or retirement income accounts. Contributions under Section 403(b) may either be made directly by the employer or indirectly through a salary reduction agreement under which the minister agrees to have his or her salary reduced and the employer agrees to transmit it to the pension board for 403(b) purposes. Where the contribution is by salary reductions, it amounts to tax-sheltered personal savings. Annuities under Section 403(b) can also be purchased from insurance companies if the denomination does not accept 403(b) contributions or if there is a preference for a funding medium other than the denominational pension board.
It would be possible for the employer to establish its own pension plan, but normally the small number of covered plan participants make this an expensive alternative if a denominational plan is available. If a denominational plan is not available, though, the establishment of a separate plan becomes comparatively more viable. Such a plan would have to meet governmental standards in order for the income on the funds being accumulated to be tax-exempt and for the contributions not to be taxable to the minister at the time they become vested. A separate plan can be self-administered (usually with a bank as trustee) or handled through an insurance company. Furthermore, a number of organizations such as banks offer master plans which tend to have lower administrative costs than if a separately designed plan were instituted.
An employer may also contribute to a simplified employee plan (usually referred to as a SEP). A SEP is basically an employer-funded individual retirement arrangement (IRA). The limit on annual contributions to a SEP is the lesser of $15,000 or 15 percent of the minister’s compensation. SEPs must be established on a non-discriminatory basis, so if the employer has more than one minister or also has lay employees, they must all be covered after age 25 and three years of service.
It is also possible for employer contributions to be paid for retirement purposes into a so-called cash or deferred arrangement operated under Section 401(k) of the code. Since such a plan is technically a profit-sharing plan, it might appear on the surface to be unavailable for use by a not-for-profit organization. However, General Counsel Memorandum 38283 indicates that, in order to promote incentives for efficiency of operations, even not-for-profit organizations are permitted to establish profit-sharing-plans. Nevertheless, because of the availability of 403(b) annuities and for other reasons, the 40l(k) vehicle has generally not been used for ministers.
The size of the pension provided by employer contributions varies greatly, depending on a number of factors such as the type of funding vehicle, length of participation, contribution level, etc. Some denominational pension plans provide pensions that amount to about 50 percent of the minister’s pay at retirement after 40 years of participation. In such cases, ministers who have participated in both the denominational pension plan and Social Security would normally receive, at least initially, a sufficient total pension to meet the general goals discussed earlier for maintenance of the pre-retirement standard of living. Of course, other denominational pension plans provide smaller amounts of pension. The degree to which these pensions plus Social Security meet the retirement goals would naturally depend on the individual situation.
A number of vehicles are available into which a minister can place personal savings for retirement purposes. As previously mentioned, the minister may participate in a denominational or other pension plan that requires member contributions, which represents a form of personal savings. Also, as previously mentioned, the minister may enter into a salary reduction agreement under Section 403(b) of the Internal Revenue Code, under which the employer withholds funds and transmits them to a denominational pension board or to an insurance company.
This really amounts to personal savings despite the required involvement of the employer in the savings process.
A well-known vehicle for personal savings toward retirement is the individual retirement arrangement (which is more frequently referred to as an individual retirement account or IRA). Everyone has been made aware through the media and through advertising by banks, investment brokers, mutual funds and insurance companies of the significant details about IRAs and their tax-saving benefits, so it is not necessary to say much here about them. However, since ministers do have the availability of both IRAs and 403(b) arrangements, it might be worthwhile for a minister to consider which is preferable. IRAs have the advantage of allowing the minister to defer the contribution for a given tax year until the date for fling his or her tax return (usually April 15 of the following year), whereas under 403(b) the payment must be made by the end of the year to be excludable from taxable income that year. Furthermore, by not involving the employer, a contribution by a minister to an IRA enables the minister to keep his or her financial affairs more private.
On the other hand, the IRA has the disadvantage that a 10 percent tax penalty is imposed if any amount is withdrawn from the IRA before the minister attains age 591/2, except as the result of death or permanent disability, while no significant penalty need be imposed upon withdrawals from 403(b) accounts. However, each 403(b) arrangement sets its own rules as to whether or not early withdrawals are permitted and as to the restrictions or penalties imposed if a withdrawal is allowed. If the right to make withdrawals from 403(b) accounts is granted, some restriction or penalties (usually minor) must be made applicable in order to avoid taxation on amounts that would otherwise be deemed to be constructively received by the minister.
The maximum amounts that a minister can contribute under an IRA now would normally be $2,000, $2,250 or $4,000, depending on marital status and, if married, whether the spouse also receives any compensation. In contrast, although the calculation process is complicated, it is usual under 403(b) that a minister can contribute up to one-sixth of his or her gross compensation. IRAs and 403(b) accounts are not interrelated, so that a minister can contribute under either without reducing the amounts that might otherwise be contributed under the other.
Comments should be made about Keogh plans which can be established by self-employed individuals. Even though a minister is treated as if self-employed for purposes of Social Security, regulations relating to Keogh plans make clear that ministers would normally be considered as common-law employees for purposes of such plans, and not as self-employed, so would not be eligible to establish Keogh plans. Accordingly, a minister should consider initiating a Keogh plan only if satisfactory evidence exists that he or she is truly self-employed and not a common-law employee.
The various types of vehicles described so far provide some degree of tax deferral in connection with contributions made. It is always possible, of course, to set aside money on an after-tax basis for use during retirement years. These funds can be accumulated in many ways, such as in stocks, bonds, real estate, precious metals, jewelry, life insurance cash values, or insured annuity contracts, and can be converted during retirement into additional amounts available for meeting retirement needs (although with liquidity problems in certain cases).
Usually, amounts available for retirement purposes from personal savings (and to varying degrees from employer contributions) can be considered as lump-sum equivalents of shares of stock, a personal residence, IRA account balances and the like so that decisions are necessary in order to convert them into funds available for retirement needs. Different decisions may be made in different circumstances, or by different people in the same circumstances. For example, if Social Security and the employer-financed pension are adequate together to maintain the minister’s pre-retirement standard of living, the items into which personal savings have been converted (be they stocks, a home, paintings,) could be utilized in a number of ways, such as:
*Accumulated, together with future earnings or appreciation thereon, and included in the minister’s estate or used for a future “rainy day.”
*The earnings used to increase the standard of living (for example, for travel delayed during the minister’s service), but capital invaded.
*The earnings and capital both used to increase the standard of living, thus reducing or eliminating any estate.
A minister who has the above choices would usually be considered fortunate. Probably a more likely scenario is that, for various reasons, the combination of Social Security and the employer-financed pension would not be adequate to maintain the pre-retirement standard of living. In such an event, the decisions needed in connection with personal savings would be the degree to which income on such savings (or income and principal) would be needed to cover retirement expenses not being met.
Decisions concerning the use of personal savings during retirement can be difficult. Amounts that may have seemed adequate at the time of retirement to cover future needs might easily become inadequate if catastrophic medical expenses are incurred, costs of living escalate greatly due to inflation or the annuitant lives to an advanced age. Some of these potential problems can be mitigated. For example, it would be advisable to use some of a retired individual’s personal savings to purchase adequate medical insurance to protect against the financial impact of costly medical needs. The threat of inflation is partly offset by automatic increases in Social Security benefits. Furthermore, some denominational pension plans also provide varying degrees of protection against inflation by increasing benefits periodically from favorable investment experience that frequently accompanies inflation.
As for longevity, annuities payable for life can help eliminate the fears of outliving resources. Thus, Social Security and pensions which are payable for life are better suited to meet the contingency of long life, since they cannot be outlived. But monies accumulated under either employer plans or personal savings in the form of investments have the inherent risk of fluctuating in value and being expended while the retiree or spouse is still alive.
Nothing can take the place of planning for retirement. There are a number of available investment vehicles for this purpose, but they are of no value if not used sufficiently in advance to accomplish their purposes. Obtain sound financial advice! Contact your denominational pension board if one exists! Such boards very often have knowledgeable staff members who can provide valuable advice. Above all, don’t delay setting aside retirement funds, because you may run out of enough time to accumulate an adequate pension level or retirement fund.
Michael Mudry is senior vice president of Hay/Huggins Inc., Philadelphia, Pennsylvania, and a partner in charge of the firm’s practice in denominational benefit plans. He has over 30 years of experience in the pension field with clients, including many of the mainline denominational churches. Mudry has written numerous articles and papers on such topics as “Asset Valuation Methods,” “Charitable Gift Annuities” and “ERISA”, which were published in periodicals. Before joining Hay/Huggins, Mudry was an actuary in the individual and group departments of Traveler’s Insurance Company.
(The above material originally appeared in Ministries Magazine.)
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