Defined Benefit Plans for Farmers: The #1 Plan Design [+IRS Pitfalls]

Farmers have very unique tax and retirement situations. But just like everyone else, they want to minimize their tax liability as much as possible. That’s why defined benefit plans for farmers can work so well.

Defined benefit plans can work great for farmers who are looking to retire in the next several years and do not want to make large purchases of farm equipment and machinery. The plans allow for large contributions that are age driven. That’s how farm owners can rapidly build retirement funds.

But even though farmers don’t traditionally have a very high taxable income, they still can be great candidates for defined benefit plans. This post will point out a few situations where a defined benefit plan for farmers makes a lot of sense. Let’s get started.

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Farmer Tax Concerns

As a general rule, farmers don’t usually have large tax liabilities. This is because as they raise their crops and sell their inventory, they can generally buy machinery and equipment to keep their tax liability low.

If a farmer can spread crop sales over several years, they could set up a defined benefit plan and contribute $100k+ each year. This could become their favored tax strategy.

For example, if a farmer finds that he has a net farming profit of $200,000 for a given year, he can buy equipment before the end of the tax year and take a full write-off. Thanks to section 179 of the IRS code, he can take a full deduction for that equipment in the year it was placed in service.

So, if that same farmer requires a tractor and other machinery for $150,000, he can take that deduction immediately to reduce his net taxable profit to $50,000. He can do this whether or not a loan is taken out to acquire the equipment.

Farmers are constantly buying trucks and equipment because farming requires high fixed assets to run the business. Also, because farmers’ income can substantially vary yearly, they can time their equipment purchases for a year with higher income.

As a result of the above, farmers typically don’t have large tax liabilities, and retirement contributions are usually not a priority for them. But as they approach retirement, their situation can change.

Defined Benefit Plans for Farmers

Not only are retirement plans great for building up tax-deferred growth, but they also give you an immediate tax deduction. But most younger farmers don’t need that immediate tax deduction because of all their equipment purchases.

But often, when a farmer gets older and is looking to retire, they’re interested less in acquiring equipment and investing in the business. They may have built up some grain inventory that they can sell. But they can acquire machinery and equipment to invest for the future. They’re looking to retire in the next several years.

Tax-deferred funding levelsExpensive to maintain
Contributions up to $300kPermanent design
Customized plan designMandatory funding requirements
Flexible funding rangeNo employee deferral

This is where defined benefit plans for farmers make a lot of sense. Because of the lower tax deductions, they can utilize a defined benefit plan to make large tax-deductible contributions. If they can commit to a plan for several years, it can result in hundreds of thousands of retirement funds. This is an excellent way for them to diversify their net worth away from farming and into a retirement plan.

What is a Defined Benefit Plan?

A defined benefit plan is a type of retirement plan in which the employer promises to pay a specified benefit amount to the employee upon retirement based on a predetermined formula. The benefit amount is usually based on factors such as the employee’s length of service, salary history, and age at retirement.

In a defined benefit plan, the employer manages the plan’s investments and assumes the risk. The employer must ensure the plan has enough money to pay the promised benefits, even if investment returns fall short of expectations.

This differs from a defined contribution plan, such as a 401(k), where the employee bears the investment risk, and the retirement benefit is based on the contributions and investment returns earned.

How to Analyze the Plan Benefits

Here are five benefits of a defined benefit plan for farm owners:

  1. Determine contribution level

    Defined benefit plans allow you to make very high contributions, which can help you save more for retirement. Depending on age and farm income, contributions can be as high as $300,000 annually. But you must have high net income to qualify for such a large contribution.

  2. Analyze tax-deductible contribution requirements

     Defined benefit plan contributions are tax-deductible, which can lower your tax liability. These plans are called “qualified” plans, which means they are eligible for an immediate tax deferral. As such, you can make sizable contributions that will grow tax-deferred and then withdraw the money at a later date when you are in a lower tax bracket.

  3. Determine if guaranteed income is necessary

    At retirement, you will receive a guaranteed income, which can help you maintain your standard of living. You might also decide to roll the money over into an IRA and take the money out as needed. You will be subject to RMDs once you turn 75.

  4. Review plan flexibility:

    Defined benefit plans are flexible, and you can customize them to meet your needs. You can even have flexible funding ranges, so you are not locked into a fixed contribution.

  5. Consider eligibility issues

    Defined benefit plans are available to small businesses, and you do not need many employees to participate. If you have part-time employees that work less than 1,000 hours, they will typically be excluded from the plan. This can help you mitigate high contributions to non-owner employees.

However, it is essential to note that defined benefit plans are more complex and expensive to administer than other retirement plans.

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Tax Concerns for Farmers

Farmers face several tax concerns that are unique to their industry. Here are a few key tax considerations for farmers:

  1. Income Tax: Farmers must pay income tax on the profits earned from their farming operation. This includes income earned from selling crops, livestock, and other farm products.
  2. Self-Employment Tax: Farmers are considered self-employed for tax purposes and must pay self-employment tax on their farming income. This tax covers Social Security and Medicare taxes that an employer and employee would otherwise pay.
  3. Depreciation: Farmers can use depreciation deductions for certain assets, such as farm buildings, equipment, and machinery. Depreciation deductions allow farmers to recover the cost of these assets over time rather than all at once.
  4. Capital Gains Tax: Farmers who sell farmland or other farm assets for a profit may be subject to capital gains tax. The tax rate on capital gains depends on several factors, including the time the asset was held and the farmer’s income level.
  5. Estate Tax: Farmers who pass away may be subject to estate tax if their estate exceeds a certain threshold. However, farmers can use several estate planning strategies to minimize or avoid estate tax.

These are just a few of the tax concerns that farmers may face. Farmers need to work with a tax professional who understands the unique tax issues facing the agricultural industry.

Paul Sundin

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