From the mailbag comes a question for the day. “I have a 403b account at the ministry where I work. I get a housing allowance. I know, when I retire, I can designate my withdrawals as Housing Allowance. If I move the money from the 403b envelope to an IRA can I still get a Housing Allowance?”

The specific question raised is part of a more general question, “How can I simplify my financial life in retirement?”

One of the many blessings we enjoy in the USA is the variety of plans available to save for our financial future. Sixty years ago, most employees hoped to have a pension plan from their employer, a profit-sharing plan, or their own savings. Beginning with the introduction of the Individual Retirement Account in 1974, options exploded. We now have 401(k)s, 403(b)s, IRAs, Roth IRAs, defined benefits, money purchase plans, and more. With multiple plans come investment choices, multiple Required Minimum Distribution decisions, and multiple income tax implications.

“Wouldn’t it be better if we could combine several accounts into one individual IRA?” Unfortunately, there is no simple answer. There are specific provisions offered under some plans that do not continue if funds are rolled over into an individual IRA. There are also income tax ramifications based upon whether we choose a Rollover, Direct Rollover, or Trustee-to-Trustee Transfer.

The answer to the mailbag question hinges on a specific provision that a rollover would eliminate. Properly designed qualified plans under Internal Revenue Code (IRC) 403(b), allow ordained individuals to designate all, or a portion of, their retirement income as housing allowance. This designation is made possible under IRC 107(2) which includes from compensation “the rental allowance paid as part of compensation, to the extent used to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.” This allowance for retirement income is specific to qualified plans sponsored by churches and religious organizations. Since an IRA is an individual account, this benefit would be lost.

Let’s briefly look at only one income tax ramification based upon whether choosing a Rollover.

The LEAST tax friendly transfer of funds from any qualified plan to an IRA is the “indirect rollover” by which an individual withdraws funds and transfers them to their chosen IRA.

  • First, the transfer to the trustee of the chosen IRA must occur within 60 days of receipt of the distribution. If this deadline passes, the entire sum will become taxable in the year the funds are received.
  • Second, the “indirect rollover” is very inefficient, because the trustee of any qualified plan is required by law to withhold 20% of the gross lump sum proceeds, regardless of whether or not the plan participant has stated their intent to rollover funds. If the plan participant deposits the net 80% received for the distribution, the individual will be liable for income taxation on the 20% delivered to the IRS for withholding.

The only way to avoid an income tax liability during an indirect rollover is to deliver to the trustee of the IRA the 80% distribution from the qualified plan, plus an amount equal to or greater than the 20% withheld and delivered to the IRS. If this process is completed, the 20% originally withheld for taxation will become available (for refund or offset of tax liability) when filing Form 1040 for the current tax year.

Simplification is a goal we all should embrace. This is notably the case in our “seasoned years.” However, before deciding to combine assets anyone has under qualified employer sponsored plans into an IRA, we recommend seeking sound advice from a qualified individual.

Here is to pursuing our passions and living financially free!