Ask the Experts October 29, 2019

Ask the Experts – Clergy Distributions That Can Be Treated as Housing Allowance

Experts from Groom Law Group and Cammack Retirement Group answer questions concerning retirement plan administration and regulations.

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“Can amounts from a 401(a) or 401(k) church plan distributed to retired clergy be treated as tax-free parsonage (housing) allowance? I thought only 403(b) plans could provide for such an allowance.”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

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The Experts answer to this is a definitive “probably—to the extent that any distributions from pension plans are eligible to be treated as housing allowance.” Certainly many church plans do provide this.

One reason for the Experts qualification on that answer is that the that the guidance itself—much of which dates back to the 1960s and 1970s—is not specific on this particular issue. But none of these old IRS rulings make a distinction based on the type of plan—whether qualified, nonqualified, 401(a), 403(b)(1), 403(b)(7), or 403(b)(9) (which only dates to 1982)—as to whether it can support the tax-free distribution of housing allowance for clergy.

Now, there have been numerous private letter rulings in the area over the years, but a private letter ruling cannot be relied upon except by the taxpayer who received it. As a review of those rulings will disclose, there are important questions around who must designate the distribution as eligible for housing allowance. (And don’t forget that designation must be accompanied by the retired minister actually spending it for housing to exclude it from income, in accordance with the rules under section 107.) But most importantly, for 30 years, the IRS has repeatedly listed the subject of “Whether amounts distributed to a retired minister from a pension or annuity plan should be excludible from the minister’s gross income as a parsonage allowance under § 107” as an area in which they will not rule.

Also, be aware that there remain groups seeking to have Section 107 declared unconstitutional by the courts. Due to the uncertainty in this area, it would be a good idea to consult with a qualified tax adviser before proceeding.

For more details on this issue, including other requirements for the retirement plan payments to be excluded from taxable income as housing allowance, please review our prior Ask the Experts column in this regard.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@issgovernance.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.
Participants October 29, 2019

Participant Views on Retirement Plan Loans Can Inform Benefit Decisions

Additional benefits and loan policy changes can keep participants from taking loans while other strategies can prevent loan default.

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Retirement plan participant loans most occur among the financially vulnerable, according to a study by Custodia Financial.

And the number one reason for taking plan loans cited by plan participants surveyed is simply to make ends meet. This is followed by paying off credit card bills and paying for medical expenses.

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Rennie Worsfold, executive vice president at Custodia Financial in Boston, says he is not surprised to see that data, and the fact that the study found the average loan amount is fairly low also shows plan participants use them for short-term financial needs. “There’s a great deal of financial stress in the workplace. We’ve also seen a spike recently in hardship withdrawals following new IRS rules,” Worsfold says.

He says this is an indication that employees need more financial help. Plan sponsors should provide financial wellness coaching and emergency savings funds. “It’s troubling that money is leaking out of DC plans and undermining retirement security,” Worsfold says.

The study also showed that employees didn’t want education about loans if they weren’t taking one. However, those who took a loan said they wanted to expedite the process to get their money as quickly as possible.

In Custodia’s self-reported survey, more than 70% of borrowers indicated they understand the limits of what they can borrow, the conditions for paying the loan back, the interest they pay, the taxes and penalties, and implications from a credit history standpoint. In the in-depth interviews, however, it became clear that there were significant knowledge gaps. For example, two-thirds of those interviewed didn’t even know whether they had defaulted on their loan.

Worsfold says in those situations, taking a loan is inevitable. He suggests plan sponsors can do a better job of interactive education at the point the loan is being taken to help people understand the implications if they don’t pay it back. Plan sponsors should explain not only the tax and penalty consequence but also the significant erosion of retirement savings. “Plan sponsors can also reinforce this education along the way. Once people have taken a loan, they are more receptive to education while the loan is outstanding,” Worsfold contends.

According to the study, more than 80% of participants are interested in timely communications to help them better manage their loan after they’ve taken it.

Plan sponsors’ fiduciary duties for loans

Retirement plan sponsors may not understand their fiduciary responsibilities when it comes to participant loans. Here’s what the Employee Retirement Income Security Act (ERISA) and the Department of Labor (DOL) say about the fiduciary responsibility for loan programs:

  • ERISA only allows loan programs where they will not diminish participant retirement benefits (DOL Advisory Opinion 95-17A).
  • Loans are a plan investment under ERISA; approving and monitoring loans are fiduciary functions; loans and a loan program must be administered for the exclusive purpose of providing benefits to the participants (ERISA 29 CFR 2550.408b-1(a)(3)).
  • Plan sponsors must take steps to preserve both plan and participant assets in the event of a (loan) default (ERISA 29 CFR 2550.408b-1(d)(vii)).
  • Loan programs fall under ERISA’s prudence standard (ERISA Section 402(a)(1)(B)).

Changes to maximum loan amounts and number of loans, as well as the imposition of fees and higher interest rates on loans can be written into loan policy statements in an effort to discourage this type of plan leakage. And, some plan sponsors have started to allow participants to sign up for ACH payments to repay their plan loans after termination to prevent default.

However, Worsfold contends not a lot of participants with loans are using that option.

The study obtained participant sentiment on three potential ways of enhancing participant access to emergency liquidity: a loan feature with extended repayment via ACH, access to consumer loans separate and apart from the 401(k) plan, and automatic loan insurance that protects against default in the event of involuntary job loss, disability, or death. While there were participants who ascribed value to all approaches, automatic loan insurance ranked first.

Worsfold says loan insurance is not widely adopted and its availability is not widely known. Custodia offers a loan insurance product.

The study report is available here.

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