Early Withdrawal Penalties (might not be so bad)

early withdrawal penaltiesEarly withdrawal penalties may have scared people off from investing in the right place! If you’re investing in a non-retirement account and your retirement accounts aren’t completely maxed out, you’re probably throwing away thousands of dollars!

All we need is 403(b)!

If you’re a minister, you can invest in a retirement account through a 403(b). A 403(b) is a tax-sheltered annuity, which means you put money in before it gets taxed and it’s sheltered from taxes while it grows. Clergy members also have a benefit of being able to withdraw from a 403(b) tax-free for housing expenses after retirement!

A 403(b) does an amazing job of lowering your taxable income (therefore lowering your taxes) and helping you save for retirement. In 2015 and 2016, you can put up to $18,000/yr into your 403(b). Pastors over 50 may also contribute an extra $6,000/yr as a catch-up contribution!

How much should I put away for retirement?

Retirement and finance gurus like Dave Ramsey tell us to invest 15% for retirement.

If you’re a pastor, it’s likely 15% of your income won’t come anywhere close to maxing out your 403(b). And don’t forget, you can also use an IRA to reduce your taxable income and save up to $5,500/yr per spouse.

Let’s pretend you’re under 50, married, and make $100,000/yr as a pastor (Hah!). If you put away 15% ($15,000) toward retirement, you still have $14,000 in potential 403(b) and IRA limits that you could be sheltering.

After I’ve funded my retirement, where do I invest?

After you’re done putting 15% of your income into retirement accounts, where should you invest?

Most people will open up a non-retirement investment account at Charles Schwab, Vanguard, T. Rowe Price, or Fidelity (BTW, these are the ONLY four places I would consider).

But why? Why would you invest in a non-retirement investment account when there’s plenty more room to invest in your retirement accounts? Three little words: Early Withdrawal Penalties.

Everyone will tell you that you need to invest in non-retirement investment accounts because:

  • Non-retirement account withdrawals are taxed at only 15% (capital gains taxes)!
  • Retirement account withdrawals are taxed at your marginal tax rate (25% for most pastors)!
  • Retirement accounts are additionally subject to 10% early withdrawal penalties!

So it seems like it would make sense. If you want to grow your investments, withdraw them, and not have them subject to higher taxes and penalties, you should invest in a non-retirement investment account. Right? Wrong.

When I did the math, it blew my mind!

It turns out that the benefit of being able to put more money into a retirement account (remember, it’s pre-tax) completely outweighs the benefits of investing in a non-retirement account.

NOTE: I AM NOT suggesting that you pillage your retirement account! I’m simply saying that if you have more room in your retirement account, it can make you thousands of extra dollars over investing in non-retirement accounts. AND it can lower your taxes!

early withdrawal penalties might not be so badLook at the comparison chart I put together. This chart assumes a one-time investment and marginal tax rate of 25%. It also assumes a 10% return on investment each year for math convenience.

The same money will buy you $10,000 of investments in a 403(b) OR $7,500 in a non-retirement account. This is because you have to pay $2,500 in taxes on the $10,000 before you invest in a non-sheltered account.

Being able to invest a higher dollar figure into your 403(b) makes the higher tax and early withdrawal penalties completely irrelevant. Even if you take an early withdrawal again and again and again, it still makes more sense to start with the higher initial investment that can be made pre-tax.

What I’m saying is this: If you have not maxed out your 403(b) AND your IRA limits, you’re throwing money away by investing in a non-retirement account.

Business Mileage and Hacking Your Commute

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tracking business mileageWhether you have a tax-free accountable reimbursement plan, a taxable ministry travel stipend, or no travel reimbursement whatsoever, you need to be tracking your business mileage.

Why?

Under a 100% accountable reimbursement plan, your church or denomination reimburses you for all of your “ordinary and necessary” ministry expenses, including business mileage, business meals or coffee with congregants, business materials such as books or software, subscriptions and licenses, memberships, vestments, event and workshop fees, continuing education, etc. This is the best way to get reimbursed. Under a proper plan, this money does not count as income and is not subject to tax (but you can’t claim your reimbursed business mileage as a tax deduction).

To get reimbursed for business mileage, you must first track your mileage! Click To Tweet

If you have a travel stipend, your church or denomination gives you an extra “travel” amount in your paycheck. This is supposed to cover your mileage. Many pastors with a travel stipend don’t track their mileage because they’re already getting paid for it. Because a travel stipend is considered taxable income, you should take a tax deduction for your business mileage and reduce the amount of tax you owe on the stipend.

But to receive a tax deduction for business mileage, you must track your mileage!

Likewise, if you aren’t receiving a stipend or a reimbursement, you’re just paying for ministry travel – gas and car maintenance – out of your own pocket. The IRS doesn’t think you should have to pay all of this business expense by yourself, so you can get a tax deduction for your business mileage. W00t!

To receive the tax deduction for business mileage, you must track your mileage! Click To Tweet

Is it really worth it?

It depends on how much you drive. But for 2016, the standard mileage rate is 54¢ per mile. (For 2015 taxes, the rate was 57.5¢ per mile, because the cost of gas was higher in 2015.)

If your accountable reimbursement plan pays the IRS standard mileage rate, you’re getting 54¢ for every business mile you drive. Assuming your car only gets 15 miles per gallon, they’d be paying you $8.10 per gallon of gas that you burn as you do your ministry (if you get 20 miles/gallon, 20 x .54=$10.80!). As you can see, that’s more than enough to pay for your gas. If you sock it all away, you could also use that money to pay for regular car maintenance, new tires, and even help save up for your next car when this one is kaput.

If you’re merely submitting your mileage for a tax deduction, calculate it at 54¢ per mile, but realize you have to hit the deductible floor first, so accountable reimbursement is usually the better deal.

What counts as business mileage?

Read more

Are you considered Clergy for tax purposes?

clergy for tax purposesThe IRS is specific about who can be considered clergy for tax purposes. This is important! Only clergy receive the “housing allowance” tax benefit, clergy-specific 403(b) distributions, and a clergy Accountable Reimbursement Plan.

You may be ordained and employed in something you consider a ministry, but the IRS may not agree. You may be a missionary, evangelist, chaplain, administrator, itinerant preacher, educator, or ordained wedding celebrant and NOT meet the IRS guidelines.

Here’s how to tell if you’re clergy for tax purposes. (ProTip: The IRS can’t figure it out by your vestments.)

5 Questions:

  1. Are you Ordained, Licensed, or Commissioned?
  2. Do you administer ordinances or sacraments (baptism, Lord’s Supper, etc.)
  3. Do you conduct worship?
  4. Do you have management or administrative responsibilities in the church?
  5. Does your church consider you a religious leader?

To qualify as clergy for tax purposes, you MUST answer “yes” to question 1 AND to a majority of questions 2-5.

If you ARE clergy, congratulations!

If you ARE clergy, you will need to understand:

  • Housing allowance, calculation, and tax benefits
  • 403(b) tax-free distributions as housing allowance
  • Exemption from Income Tax withholding
  • Calculating and paying Quarterly Estimated Taxes (or arrange to withhold on W-4)
  • Paying both parts of SECA (not FICA)
  • Setting up a 100% Accountable Reimbursement Plan

Clergy Financial Coaching can help you understand the unique financial and tax needs of pastors and walk alongside you in ministry to find financial wholeness.

Schedule a FREE 30-minute coaching session to get some clarity on your financial future!

Who to pay when you can’t pay everyone

When we first made a commitment to NEVER use debt again and started putting together a real budget, we realized we were coming up $300 short of being able to make all of our payments each month!

who to payThis isn’t as rare as it should be. Most Americans are living paycheck to paycheck and have no emergency fund or savings they can go to if something goes sideways.

So when you’re short of funds, which bills do you pay and which ones do you let slide? Who to pay first?

Believe it or not, most people prioritize the wrong payments. And that can really get them into trouble.

I’ve counseled several pastors who can’t pay their rent, but they’re all up to date on their MasterCard payment… You’ll notice that your credit card payment is all they way down at the bottom of this list.

Here’s who to pay first and why.

1. Tithe
Biblically, tithing is not just about funding the church. We return 10% to God as a radical core understanding that God owns everything and we are His managers. This is about prioritizing God and trusting our lives completely to Him. This is also about building a habit of giving and generosity into our characters. For many pastors, tithing is actually a condition of employment. If you don’t tithe, you may get fired. I know that takes the joy out of giving. But seriously, why are we pastors if we can’t get this one right?

2. Food
This is a “necessity.” You need food to live. Buy food.

3. Housing and Utilities
This is a “necessity.” You need to make sure you and your family have a place to live–with heat, electricity, and water. If it doesn’t fit your budget, you might need to live in a smaller place, but you MUST pay your mortgage or rent.

4. Transportation
You probably need transportation to do your job. You may not need the SPECIFIC car you have… But you do need transportation to get where you need to go. If this means you get rid of your car and use Uber or public transportation, fine. But some form of transportation is a “necessity.”

5. Taxes
Taxes and government obligations, like child support, come before your other “debts.” The IRS is notoriously nasty if they don’t get their money, so be sure to pay them on time every time. If you don’t pay them, the penalties and fees are high and they’ll garnish your wages (i.e. you’ll pay them anyway, just more).

6. Secured Debt
Secured debt is anything you bought on payments using collateral. Your home improvement loan may have placed a lien on your house. That means if you don’t pay your debt, they can come and take your house. If you buy a new sofa or dining room set on credit, they can come take away your furniture if you don’t pay. Car loans are also secured debt. If you don’t pay your car loan, they can come take your car away. Pay secured debt BEFORE you pay unsecured debt.

7. Unsecured Debt 
Unsecured debt is the LAST thing you should pay. I know it feels like it’s the first thing you should pay, but that’s because you’ve been using your unsecured debt (credit cards) in place of an emergency fund. So you’re afraid if you don’t pay your debt, they won’t let you use your credit card anymore. Yes. That may be true. But unsecured debt, like credit card debt and medical debt are the safest debts to let slide.

If you find that you can’t pay all of your debts, don’t hide in shame from the debt collectors. Be proactive. Call your creditors before they call you. Tell them you won’t be making a payment this month and why. Tell them what you can afford to pay, if anything.

We were able to work with a credit card company to reduce our monthly payment from $980 down to $422 per month. That gave us just enough wiggle room in our budget to start getting some traction. They shut down the card and we couldn’t use it anymore. But the new arrangement brought the interest down from 24.24% to a measly 2% for repayment.

Let me know if there’s any way Clergy Financial Coaching can walk alongside you and support you in your pursuit of financial wholeness. It’s our specialty. Schedule a FREE 30-minute strategy session and I’ll be more than happy to help you get on the right path with your finances!

Integrity Check: Reporting ALL of Your Income

tax dodgerAre you a tax dodger?

As a pastor, you may have multiple sources of income. Most of your income will likely be reported on a W-2 from your church or denominational office. If you’ve published some books, you’ll get W-2s from your publishers. You might even get a 1099-MISC for a bigger speaking engagement.

But for many things you do as a pastor, you will not receive any tax forms reporting that income. Funerals, weddings, pulpit supply, guest speaking, book or CD sales, bonuses or gifts from the church… All are taxable, even if you don’t get the number printed on some legal-looking form. It may even be a cash payment.

But ALL income derived from your job is taxable (even housing allowance is taxable for Social Security and Medicare). You MUST report ALL of your income.

This is an integrity issue.

It would be easy for me to be lazy and “forget about” the $500 pastor’s appreciation gift the church gave me last year. I’m paid by denominational offices, so the bonus wouldn’t show up on a W-2 and it’s under $600, so they wouldn’t have to give me a 1099-MISC… I could just leave it off of my tax forms. If I had no integrity.

You may not like to pay taxes. You may somehow even think that Jesus’ command to “render unto Caesar that which is Caesar’s” doesn’t apply to you. As long as you don’t get caught. Who’s going to know?

But it’s not worth the rotting of your soul to save a few dollars on taxes. Deception is deception. Even if it’s the US Government you’re deceiving.

Jesus said it this way: “What does it profit a man if he gains the world and loses his soul?” A modern translation might as well say, “What does it profit a pastor to save a few hundred dollars on taxes when the deception rots his integrity?”

Make sure you go over all of your income from last year and report it. If you didn’t keep good records, you may need to go through your calendar and your bank statements to jog your memory. Don’t be a tax dodger. Don’t let the easy slide steal your integrity.

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