Yes, a farmer can have a cash balance plan. In fact, a cash balance plan for farmers can be an excellent tax and retirement strategy.
Because these plans are driven largely by age, they work well for farmers who are planning to retire from operations in a few years. Farmers are able to quickly amass retirement wealth while getting substantial tax deductions in the process.
For farmers close to retirement, it can be common to have over $1 million in inventory. If they sold it all in a given year, they would have a large tax liability without generating additional tax deductions to offset. That’s where a cash balance plan can help.
Here is a summary and then we’ll dive into the specifics.
The best way to structure a cash balance plan for farmers:
- Farmers get immediate tax deductions without needing to borrow money or invest in machinery or equipment to shelter their farm profits.
- If the farmer can spread inventory sales over several years, they can open the cash balance plan and fund it each year.
- Rather than incur a large tax bill when they are close to retirement, taxes can be deferred until the funds in the cash balance plan are distributed.
How Does a Cash Balance Plan Work?
A cash balance plan is a defined benefit retirement plan that is becoming increasingly popular among employers. In a cash balance plan, an employer contributes a specified amount each year to an employee’s account.
A cash balance plan is a type of defined benefit plan that specifies the benefit to be received upon retirement in terms of a hypothetical account balance. The account balance is based on a formula that takes into account the employee’s salary and years of service.
This account grows with interest and is guaranteed to provide a specific benefit upon retirement, regardless of investment performance. Unlike traditional defined benefit plans, which provide a fixed monthly benefit, cash balance plans give participants an account balance they can take with them if they leave their job.
Cash balance plans are attractive to both employers and employees for several reasons. For employers, cash balance plans offer more predictable and manageable retirement benefit costs than traditional defined benefit plans.
They also allow employers to attract and retain employees by offering a competitive retirement plan. For employees, cash balance plans provide the security of a guaranteed retirement benefit while allowing for portability if they leave their job.
| Pros | Cons |
|---|---|
| Flexible Funding | IRS Permanency Concerns |
| Tax-Deferred Investment Growth | Conservative Investments |
| Contributions of $100k+ | Higher Admin Fees |
| Custom Plan Design | Mandatory Contributions |
However, cash balance plans can be complex and expensive and may only be appropriate for some employers. They also have specific regulatory requirements and limitations that employers must comply with to maintain the plan’s tax-qualified status. Therefore, employers must work with an experienced retirement plan provider or financial advisor to determine whether a cash balance plan suits their business and to ensure they comply with all regulatory requirements.
Plan Advantages for Farmers
Farmers with specific types of certain crops, such as grain, are able to control their net income by determining annually how much crop inventory to sell based on their taxable income. They often spread the crop sales over several years to limit their marginal tax rate.
Advance planning and pre-determing how much net profit they will have can give them assurance to open a cash balance plan and commit to funding it for several years.
The plan gives them significant annual tax deductions that can help them reduce their current tax liability. This allows them to get an immediate tax deduction without having to invest or borrow funds for more equipment and machinery to shelter their income.
Before a farmer retires, you can structure the plan to allow older farmers to receive more assets built up in the business as retirement contributions. The funding is tax-deferred until withdrawn upon retirement.
Cash Balance Plan for Farmers
Farmers, like other business owners, face a variety of tax issues related to their operations. Some of the key tax issues that farmers should be aware of include:
| Tax Type | Description |
|---|---|
| Income tax | Farmers must pay federal and state income taxes on their earnings. They can deduct expenses related to their farming activities, such as the cost of seeds, fertilizer, equipment, and labor. |
| Self-employment tax | Farmers who operate as sole proprietors or partners are subject to self-employment tax, which covers Social Security and Medicare taxes. This tax is based on the farmer’s net earnings from their business. |
| Depreciation | Farmers can take depreciation deductions on their equipment and other capital assets over a period of years, which can help reduce their taxable income. |
It’s important for farmers to work with a knowledgeable accountant or tax advisor who understands the unique tax issues faced by agricultural businesses. They can help farmers take advantage of available deductions and credits, as well as plan for future tax liabilities.
Tax and Retirement Planning for Farm Owners
As a farmer, you can use several tax strategies to minimize your tax liability and maximize your profits. Here are a few:
- Take advantage of deductions: Farmers are eligible for various deductions, including those related to business expenses such as seed, fertilizer, and labor. You can also deduct machinery and equipment purchases, property taxes, and loan interest expenses.
- Use cash accounting: As a farmer, you can use cash accounting, which allows you to defer income to the next tax year by delaying billing or receiving payments until the following year. This can help lower your current year’s tax bill.
- Use the Section 179 deduction: The Section 179 deduction allows you to deduct the full cost of qualifying assets in the year they are purchased rather than depreciating them over several years. This deduction can be beneficial for farmers investing in equipment and machinery.
- Maximize retirement contributions: Farmers can contribute to retirement plans such as a SEP IRA or a solo 401(k). Contributions to these plans are tax-deductible, reducing your current year’s tax bill, and they also help you save for retirement.
- Consider income averaging: Farmers often have fluctuations in income from year to year. Income averaging allows you to spread your income over several years, which can help lower your tax liability in years when your income is higher.
Working with a tax professional familiar with the specific tax laws and regulations related to farming is essential to help you develop the best tax strategy for your situation.
Section 179 Deductions
Farmers can use Section 179 to deduct the cost of certain qualifying assets used in their farming business. Section 179 is a tax allowance that allows businesses to deduct the entire cost of qualifying equipment or property in the year it is placed in service rather than depreciating it over several years.
To be eligible for the Section 179 deduction, the asset must be tangible property, such as equipment or machinery, and must be used more than 50% for business purposes. The deduction is subject to annual limits set by the IRS, and the maximum deduction for 2022 is $1,050,000. The deduction begins to phase out when the total amount of qualifying property placed in service during the year exceeds $2,620,000.
Farmers can use Section 179 to deduct the cost of many types of equipment and property used in their farming operations, such as tractors, combines, irrigation equipment, barns, and storage facilities. The deduction can help farmers reduce their taxable income and save money on their tax bill.
Farmers need to consult with a tax professional or accountant to determine their eligibility for the Section 179 deduction and ensure they take advantage of all available tax benefits for their farming business.
How to Structure a Farmer Plan
Here is the 5 step process to setting up a plan:
- Determine the desired benefit
The first step in structuring a cash balance plan for a farmer is to determine the desired benefit level. This will depend on factors such as the farmer’s age, income, and retirement goals. It also will consider the farmer’s expected business profit.
- Choose an appropriate interest rate
Cash balance plans are required to have a specified interest rate that is used to determine the plan’s funding level. The interest rate should be chosen based on current market conditions and the expected rate of return on plan investments. Most administrators will use a standard fixed rate such as 4% or 5%.
- Select a funding method
There are several funding methods for cash balance plans, including a level percentage of pay, a fixed dollar amount, or a hybrid of the two. The funding method should be chosen based on the farmer’s financial goals and cash flow needs. The TPA will help you establish the funding method and the desired contribution level.
- Determine eligibility and vesting
Cash balance plans can be designed to provide benefits to all employees or only a select group. The plan should also include vesting provisions that specify when participants are entitled to receive their benefits. Most eligibility concerns will not be an issue because farmers typically qualify for solo plans.
- Consult with a financial advisor and actuary
Finally, it’s essential to consult with a financial advisor and actuary to ensure the plan is properly structured and compliant with all legal and regulatory requirements. They can also help determine the optimal contribution level and investment strategy to maximize retirement savings.
Final Thoughts
Cash balance plans can be attractive to farmers because they offer the potential for higher contributions and retirement benefits compared to other types of retirement plans, such as a 401(k) plan. In addition, they can provide more stable retirement income, which can be especially important for farmers who may have fluctuating income levels throughout their careers.
However, cash balance plans are more complex than other retirement plans, so farmers should consult with a financial advisor or retirement plan specialist to determine whether a cash balance plan is right for their particular situation.
