Retirement plans can be as unique and complex as the farms and families they serve. As farmers near retirement, some will realize that an out-of-the-box solution is not going to meet their needs.
Below are some options for farmers who wish to set aside more for retirement than an IRA or SIMPLE IRA will allow. I’ll also share how to use a defined benefit plan to offset untaxed grain inventory.
If you want to contribute $50,000 to $75,000 annually and have very few employees, setting up a 401k plan might make sense. In this case, you could defer $17,500 for you and your spouse (assuming a salary of at least this amount is paid). If you and your spouse are 50 and older, you can each elect to defer an additional $5,500. Plus, you can to contribute 25% of net wages or net self-employment income as additional contributions.
For example, let’s assume farmer Tom has a C corporation that pays a salary of $40,000 and his spouse receives a salary of $20,000.
"It’s not uncommon for farmers nearing retirement to have grain inventory sales in excess of $1 million with no off-setting deductions."
Pay and Defer. Both Tom and his wife can defer $17,500 (or $23,000 if 50 and older) into their 401k plan.
The corporation can fund another 25% of their salary or $15,000. In this case, $50,000 has gone into the retirement plan. The corporation gets to deduct the $15,000 contribution, while their W-2 wages will be reduced by the $35,000 deferral.
If we bump Tom and his wife’s salaries from a combined $60,000 to $150,000, then the amount allowed for the 401k contribution increases from $15,000 to $37,500, or a $22,500 increase. However, one drawback to this example is the extra Federal Insurance Contribution Act (FICA) and Medicare taxes owed on the earnings. Also, if commodity wages are used, then Tom and his wife can increase their 401k contributions without incurring additional payroll taxes.
If Tom has employees, he must contribute some funds for the employees, which can be a great employee benefit.
Grain for Retirement. It’s not uncommon for farmers near retirement to have grain inventory sales in excess of $1 million with no off-setting deductions. This can lead to a large amount of tax due at retirement without proper planning.
For farmers who are interested in setting up a defined benefit plan, we recommend starting at least five years before your target retirement date. Setting up a customized defined benefit plan allows farmers to sell this built-up grain inventory without incurring any additional tax.
A defined benefit plan allows a farmer to deduct a much higher contribution than a 401k or other defined contribution plan.
For example, let’s look at a farmer with grain inventory in excess of $1 million. Assuming proper planning of the salary, the farmer can sell an extra $200,000 of grain inventory annually during a five-year period and then deduct a $200,000 contribution each year to the defined benefit plan to offset the extra grain sales.
Although income tax will be due when the farmer starts to collect retirement benefits, this tax can be spread throughout his lifetime at lower tax brackets. Due to the complexity of these types of plans, they generally only make sense if the farmer anticipates needing a deduction in excess of $100,000 annually. Below that number, some type of defined contribution plan will make more sense.
These are just two of the many options available to help with your retirement goals. It’s important to start planning early and to discuss these options with your tax and investment advisors.
Every year you delay planning, the amount of money available for your retirement shrinks.
Paul Neiffer is a tax accountant with CliftonLarsonAllen and author of the blog, The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at paul.neiffer@CLAconnect.com.