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questions about maximizing 403b deferrals


nottheonlydreamer
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Hi All,

My soon-to-be (marrying in 2016) minister hubby is facing some very large tax liabilities and has zero retirement savings (outside of Social Security), due to pathetic and egregious (if not downright “criminal”, in my opinion) tax return preparation and planning by his former tax preparer, bad and/or non-existent advice from his home church and somewhat willful ignorance of his own financial and tax situation.

I am involved because A) I realized the first time I saw his tax return that something was very wrong and started asking questions B) am in the accounting field (not a preparer or CPA, though) and love it so I understand all of “this” much more than he does and, C) am a bit panicked at the thought of having my modest retirement savings the source of support for both of us in the not-so-distant future (he is 59).

He/we do now have what I believe to be quite adequate tax representation but I would also like to get input from those of you who seem to know what you're talking about and, with the October tax deadline looming, his CPA is somewhat unavailable.

For now, we have increased his withholdings substantially and are about to open a 403(b)9 in order to defer income to decrease his tax liability. My questions regarding the TPA are probably going to be another post.

He makes approximately $30,000 in salary and $20,000 via housing allowance. My fantasy is that we can defer the majority of his compensation to the 403b plan (we can both live off of my income).

If I understand correctly, income deferred into a 403b is exempt from both income and SE taxes. Am I correct?

If I understand correctly his housing allowance cannot be deferred to a 403b because it is not considered taxable income (even though he pays SE tax on it). Am I correct?

If he cannot defer the housing allowance, can his church contribute into the 403b instead of paying the housing allowance (which would reduce the SE tax)?

If the church can contribute:

Would that make it impossible for the retirement distributions be allocated to housing expense?

If the church cannot contribute:

Should we request that the church reduce his housing allowance and increase his salary in next year's contract in order to defer a larger amount of income?

By the way, no, he did not file form 4361 because he was not aware of it until it was too late (and, likely wouldn't have filed it anyway because he doesn't really feel “right” about it).

My apologies for the long post and my thanks in advance for any input you have.

~Stephanie

ETA clarification.

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If I understand correctly, income deferred into a 403b is exempt from both income and SE taxes. Am I correct?

Yes. I assume he qualifies as a "minister of the Gospel" which means he is treated as self-employed for tax purposes. Because of that, he has no FICA/Medicare withholding. That means the election made to defer into the 403(b) plan is not subject to FICA/Medicare tax - the deferral directly reduces both his taxable income and reduces his SE tax that he pays. Thus, it will never be subject to FICA/Medicare until sometime when Congress changes the tax rules on this.

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A trap that many fall into is to forget that by reducing FICA also reduces the eventual SS Retirement benefit and by not paying into the Medicare Fund might also cause a future problem. I have not seen any retirement investment that beats the "return" from paying into SS through FICA. I have not seen any retirement investment that beats the "return" of SS Retirement Benefit PLUS Medicare. Considering the cost of health care coverage at older ages, Medicare is a great bargain. I suggest that you also look at the overall end result and not just focus on reducing current tax liability.

Have you seen any proof of, or have you even seen, the actual historical performance of any 403(b) product ? Remember that past performance is not an indicator or guarantee of future performance. When you select your 403(b) investment and amount, use the SS Calculator on the SSA website to project what his SS Retirement Benefit would be if he instead contributed.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Okay. I will state some crazy opinions since it's getting late and I can't help myself.

Based on the current rules, he will be eligible for all of Medicare regardless of how much he puts into that "fund" (assuming it even still exists when he becomes eligible). So I think the payment of Medicare taxes is a total throw away in this particular case. To me, that means the full 15.3% self-employed contribution should be examined.

I think you are suggesting that an invested contribution of 15.3% per year (not 7.65%, because he is self-employed) of that deferral would result in a smaller social security benefit than the amount that the theoretical future structure of social security will provide as a benefit, even when considering the spouse as a higher earner and taking into account the family maximum limitations that would be imposed?

Maybe. Especially if he is a baby boomer, then you're probably right. That generation will likely get every dollar promised under the program.

Of course, that might be on the backs of the following generations of taxpayers. I know it is impossible to predict any future changes to the program, but it has changed, and will likely change again. The longer that this truly needed change gets delayed, the more drastic the cut in benefits will be for those following generations. I think his current age matters a lot in this decision. But regardless, I see no accurate prediction available here.

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Thanks to everyone for your input. There is, obviously, a lot to consider. We ARE working with a CPA and I work with CPAs and lawyers (though none with familiarity of clergy income or 403bs).

Please keep the input coming, if you'd like.

Keep in mind that he has paid into "the system" since he was in his teens (though, of course, his income in the early years was quite low). Not that I'm an expert but I don't see where not paying into Medicare on all of his earnings at age 59+ might cause a problem.

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If he is already over age 59.5, it might very well be that his highest 35-year average earnings for purposes of determining his social security benefit has been established from prior wages. Each year is adjusted for inflation. If his earnings now would be higher than some of his prior earnings (adjusted for inflation), then Gburns may be correct. Otherwise, deferring would not impact his social security benefit. Best to run it through the calculator.

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As John Feldt pointed out Medicare should be a throwaway in this case. You should check his eligibility and also see if you can a premium estimate.

Regarding SS Jon also advised "Best to run it through the calculator". Your spouse is 59+ and you stated that "his income in the early years was quite low" which means that his highest 35 years might not have established as much of a retirement benefit as you might think.

If however, because you work with CPAs and lawyers and you "ARE working with a CPA", which you somehow think is relevant to the issues, causes you think that it is better to guess than to actually check. I wish you good luck.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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As John Feldt pointed out Medicare should be a throwaway in this case. You should check his eligibility and also see if you can a premium estimate.

Regarding SS Jon also advised "Best to run it through the calculator". Your spouse is 59+ and you stated that "his income in the early years was quite low" which means that his highest 35 years might not have established as much of a retirement benefit as you might think.

If however, because you work with CPAs and lawyers and you "ARE working with a CPA", which you somehow think is relevant to the issues, causes you think that it is better to guess than to actually check. I wish you good luck.

I'm not sure what I wrote caused you to think that I think it's better to guess than check but I, assure you, I don't. Working with a CPA (as in we have retained a CPA to not only prepare tax returns but to advise on tax implications of financial decisions) is, I think, absolutely relevant.

If he is already over age 59.5, it might very well be that his highest 35-year average earnings for purposes of determining his social security benefit has been established from prior wages. Each year is adjusted for inflation. If his earnings now would be higher than some of his prior earnings (adjusted for inflation), then Gburns may be correct. Otherwise, deferring would not impact his social security benefit. Best to run it through the calculator.

Thanks John. His highest earnings years are prior to 2010. I'll run the numbers through the calculator.

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It is a common mistake and one which CPAs try to gloss over, to believe that a CPA is knowledgeable and competent "to not only prepare tax returns" and "to advise on tax implications of financial decisions". CPAS prior to around 2004 did not have to pass the taxation portion of the CPA Exam, and many, it seems in most years the majority, did not pass it. Currently, they do have to pass the Regulation section, of mainly theory and which is only a 3 hour examination. But, I guess 3 hours is still more than the older ( pre 1990) CPAs had which was no taxation examination. The result is that there are many CPAs who either did not have to take or did not have to pass.

By comparison a JD or LLM in taxation has 28 -32 hours of examination.

The old Enrolled Agent Exam was 28 hours.

Also the CPA coursework does not cover personal financial planning.

The end result is that most likely, your CPA did not learn tax return preparation or financial planning as a CPA, but did so outside of being a CPA.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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