How should you contribute to your retirement plan?
Once you make the decision to participate in your employer's retirement plan, you need to decide how much to contribute. Your church may be making a contribution on your behalf, but you can also make your own contributions. The money that you contribute is withheld from your paycheck and is sent to the plan custodian. Once your money is invested, you will be able to go online, see your account, and manage it.
How much can one person contribute in a plan year?
The IRS gives us contribution guidelines (indexed each year for inflation). Currently, you can contribute up to $20,500 in a calendar year, for 2022. If you're over 50, there's an additional $6,500 that can be contributed as a "catch-up contribution." This typically increases slightly on an annual basis.
There are two ways you can contribute to your retirement plan
With traditional retirement plans, contributions are made pre-tax, reducing taxable income. Funds contributed before tax grows in the retirement account tax-deferred, which means that tax will be paid at a later date. When the funds are withdrawn at retirement, those funds are taxable so taxes are paid at that time.
Funds inside the following plans grow Tax-deferred:
- Traditional IRA
- Simple IRA
- 457 Plan
Contributions to Tax-deferred plans reduce taxable income.
Distributions from tax-deferred plans are taxed.
(Licensed or ordained ministers may be partially exempt.)
Under Roth, contributions are made after-tax so there are no tax savings when the contribution is made. Funds grow in the retirement account tax-free and are withdrawn tax-free at retirement. No taxes are paid at retirement because taxes were paid when the contributions were made. Roth contributions are most advantageous for people who do not need the tax break today as they are in a low tax bracket and for missionaries who can take advantage of the Foreign Earned Income Exclusion.
Funds inside the following plans grow Tax-free:
- Roth 403(b)
- Roth 401(k)
- Roth IRA
- Section 529 College Savings Plan
- Coverdell Education Savings Account (formerly called Education IRA)
Contributions to Tax-free plans do not reduce taxable income.
Employer Contributions: Basic and Matching
When an employer contributes to the retirement plan on behalf of an employee, those contributions are made in one of two ways:
Basic Employer Contribution
This is a contribution that an employer makes into an employee's account regardless of the employee's participation in the plan. It is usually a percentage of the employee's salary and often increases each year the employee remains with the organization. Your ministry's retirement plan may or may not include a Basic Employer Contribution.
Matching Employer Contribution
This contribution only occurs when the employee contributes into the retirement plan. When the employee contributes, the employer also contributes a certain amount, "matching" some percentage of the employee's contribution, usually up to a specified maximum percentage of the employee's salary. A matching contribution is often described in this manner: A dollar-for-dollar match, up to 6%. This means that the employer would contribute $1 for each dollar the employee contributes, up to 6% of the employee's salary.
A Matching Employer Contribution is generally regarded as "free money" and employees should take advantage of these funds as a tool to build their "Future-Funded Ministry" plan. Your ministry's retirement plan may or may not include a Matching Employer Contribution.