Should your contributions to your retirement account be pre-tax or after-tax?
Pre-tax, or traditional, means that you don’t pay taxes with every contribution, but you will pay taxes when you withdraw the money.
On the other hand, the after-tax option, or Roth contribution, does not save taxes now but can if taken out tax free assuming the account has been in place for at least five years.
The Roth option is valuable and important to understand. Many in full-time ministry, or those on the lower end of the income spectrum, do not pay much income tax. We all complain about taxes, but you can make a mid to high 5 figure income with 3 children along with a commitment to tithing and be in a very low tax bracket.
One of the strong benefits of contributing to a retirement plan is the tax deductibility of your contribution. If you pay little income tax, that incentive goes away. A number of years ago, a congressman named Roth lead a campaign to create another tax incentive to save—no tax savings now, but no taxes to pay when you take the money out.
Interestingly, we sometimes pay more in taxes during retirement than during our earning years. That makes the Roth option very attractive. When you know that all or part of your Future Funded Ministry income will not be taxed, the incentive to save increases.
For most who pay little income tax, Roth is the way to go. Note that the Roth option is only available for contributions by the participant, not for employer contributions. Please discuss this option more with your tax advisor.
To sum it up:
Roth contributions are after-tax contributions, meaning you don't get any reduction in taxes for making the contribution. However, when you go to withdraw the funds in retirement, you won’t pay any taxes on the funds—what you initially contributed or the earnings.
Roth makes sense for people in a low tax bracket, pastors, and overseas missionaries.
Traditional contributions are pre-tax contributions that do reduce your taxes today. However, the contributions grow tax-deferred, meaning that when you withdraw the funds, you will pay taxes on the amount you receive, both the initial amount and the earnings.
Traditional makes sense for people in a high tax bracket.
Lastly, you do have the option to divide your contributions between traditional and Roth.
Looking for faith-based IRA options? The FaithBased IRA from Envoy Financial could be the perfect solution for you!