Maxing Out Your Retirement Benefits

Dear Michael: We have been following your articles on the different retirement plans we can use as farmers and ranchers. We have a unique situation where we are planning to quit farming, but all the money we have in our system right now - which is in the cycle of either crops in the bin, payments due from the elevator or government payments, or inputs back into next year’s crop - is going to be taxable to us when we quit farming. As we listen to the government’s plan for increasing the taxes on the wealthy, we know as we withdraw this money from our agri-business we will end up in the highest tax brackets possible with little or no deductions. What do we do in a case like this? - Cycling Down.

Dear Cycling: Every farmer goes through this transition cycle and without most people really paying any attention to how much it has increased over time, a lot of money can start rolling about in the annual cycle described above. Over the past ten years, the amount of money in this cycle of the average farm has more than quadrupled in size. People don’t see it because right now the money is used to meet quadrupled expenses. But one day, when expenses stop, at retirement, all this capital cycling through your farm business comes popping out - fully taxable. And, you are right, the tax rates are going to be a lot higher in the future when you take this money out.

All the plans I’ve described in prior articles - SEP’s, IRA’s, SIMPLE’s - have been ‘defined contribution’ plans. In other words, the IRS tells you how much you can contribute. Depending on your investment experience on these contributions determines the lump amount you’ll have for retirement.

The problem with most of these retirement plans is two-fold. One, the amount you can place into these plans starts phasing out at approximately one hundred and thirty thousand dollars per year by IRS. By one hundred and sixty-four thousand dollars income, most traditional ‘defined contribution’ plans are unavailable.

The second problem is how do you get a large lump sum out of your operation that’s grown to six, seven or eight hundred thousand dollars without giving half of it away in taxes? The limits on what you can put into the ‘defined contribution’ plans are so low, typical defined contribution plans won’t give you a lot of tax relief!

For the wealthy people - even people who are just temporarily wealthy like you, during this short time period, as you remove money from your agri-business - have options.

IRS also allows us to set up our own ‘pension’ plan for individuals, just like a state pension plan, or General Motors or any other large company that promises to pay a percentage of the retiree’s pre-retirement income to them after retirement.

For a farmer or rancher, this is invaluable as you can decide you want to receive a percentage of your income for the remainder of your life. If you were averaging seventy-thousand dollars per year in income prior to retirement and want to receive sixty percent of your pre-retirement income, it would take a large amount of money to fund such a pension plan.

This is where we can tuck all the money that would have come out of your farm operation in taxable funds. Because the ‘defined benefit’ is based on a percentage of earnings, and because most people are older when they consider this, IRS allows us to put large amounts of tax deferred money into a ‘defined benefit’ pension plan.

Normally, IRS wants to see three years of deposits. By deferring grain payments or other payments over a period of time, income is easily adjusted to meet the three years. The plan has to be filed in the year of when the income will be counted, but the deposits do not have to occur until you file your final tax statement either in March or April. You have a maximum amount you can contribute - based on income - but you can always opt for a lower percentage of your salary to meet your desired contribution level if the maximum is too much for you to handle.

Once you cease making payments, the lump sum acquired - plus the interest earned - can be rolled to a Standard IRA - and, in the IRA, now you can opt how you want to make withdrawals versus the original ‘defined benefit’ amount. We don’t use any type of plans which may risk any principal. We always want to ascertain both the principal and the interest growth of the plan. You shouldn’t gamble with your retirement dollars - especially now!

For those people who need more of a contribution limit than you’re the SEP, IRA or SIMPLE retirement plan, the ‘defined benefit’ is one of many plans you can use to really leverage your money out of your farm operation. If you might need help in this area, give our office a call.