By Larry Evans
Do you ever get concerned about your financial future?
Sure, you do—we all do. But if you’re a member of the baby boomer generation, at the age of retirement, or getting close to it, that concern can be amplified to the point of fear.
Recent studies will tell you that 65 percent of boomers fear they won’t be able to retire comfortably, and more than 70 percent will be looking to delay retirement. While those numbers may not be representative of boomers and other age groups in a family business of farming or ranching, they still present cause for concern.
Retirement is an elusive term. It has a different meaning to almost everyone you ask. But most consider it a time when current business activities change from active to passive status. However, once retirement is defined, the real work begins—funding it—and that should start at the earliest possible time.
Funding via Retirement Plans
For a farming or ranching operation with only family members as employees, the standard 401(k) retirement plan could be established. But, the rules related to covering non-family member employees and non-discrimination coverage or benefits makes these plans less attractive. Plus, the cost to establish and administer a 401(k) plan isn’t cheap.
An Alternative
An alternative retirement plan, one that can work for a self-employed individual, as well as a business, is the Simplified Employee Pension (SEP) plan. You should become familiar with this simple but beneficial retirement plan type. It is very flexible in operation, fitting well for the needs of a family farming or ranching business.
Features of a SEP
A SEP-IRA is a simple plan with excellent features.
- Easy to establish. A SEP can be adopted by using Internal Revenue Service Form 5305-SEP, or a SEP prototype or individually designed plan document can be used. Whatever style is used, a copy of the adoption document will be provided to covered employees.
- No annual filing requirement.
- Can be used by any size business.
- No major start-up or on-going administrative costs.
- Allows a retirement contribution of up to 25 percent of each employee’s (or self-employed) pay. There is an annual contribution limitation for each employee, or self-employed individual ($54,000 in 2017 and $53,000 in 2016).
- Flexible annual contribution levels allow higher contribution rates to be used in good years and lower rates to be used in lean years.
- Equal contribution percentage is used for all employees. This will need to be considered if non-family employees are hired by a family business.
- The plan can exclude coverage for employees under age 21, and those employed less than three out of the last five years, or those receiving less than $600 in compensation. Also, it can exclude certain employees covered by a union agreement with bargained benefits or nonresident alien employees who do not have U.S. wages, salaries or other personal services compensated from the employer.
- Uses an Individual Retirement Account (IRA) as the place where an employer makes the retirement contribution to an employee.
- Once a SEP-IRA contribution is made it is 100 percent vested to the employee. There is no forfeiture back to the employer.
- SEP-IRA contributions can be withdrawn subject to the limitations imposed on traditional IRAs.
The Best Part
Most other retirement plans, including those for self-employed individuals, need to be established in the year for which a contribution is made. Therefore, if those accounts were not opened in 2016, then it is too late to start one of those types of accounts and get any benefit in 2016. But, not if it is a SEP-IRA.
A SEP-IRA can be set up and funded up until the extended due date of the tax return in which the retirement contribution will be deducted. This is a major tax planning benefit.
An Example
Here’s an example of the benefit that can be achieved using a self-employed individual, and the same concept is applicable to a business.
Ron, who is 64, owns and operates a farming and ranching business that for calendar year 2016, showed a profit and created $100,000 of self-employment taxable income for Ron. Due to business cash flow demands during 2016, which included paying tax estimates, Ron wasn’t able to set aside any funds for retirement during 2016. Ron anticipates that his income tax for 2016 will be taxed at an effective rate of 30 percent, resulting in tax of $30,000. But, he was fortunate and got a copy of this article discussing a SEP-IRA and decided to check it out.
Ron doesn’t currently have the cash, but has a transaction closing in July 2017 that will create $25,000 of available cash flow.
Ron then does some proactive tax planning. He extends his personal 2016 tax returns until Oct. 15, 2017. Next, he sets up a SEP-IRA for the year 2016. Once the $25,000 transaction closes, he calculates that the tax cost of that transaction will be $5,000, leaving $20,000 which he then contributes to the recently adopted SEP-IRA (the $20,000 contribution was the maximum amount Ron could make to the SEP-IRA for 2016). Once the contribution had been made to the SEP-IRA, Ron filed his 2016 tax returns.
The result of the $20,000 contribution to the SEP-IRA, using the 30 percent effective tax rate, is a savings of $6,000 in 2016 tax liability… not bad for a 2016 deduction created seven months after the end of 2016. But, the biggest benefit was $20,000 put away for retirement.
Summing It Up
Retirement will come with a little less fear for Ron, and you can do the same with some proactive retirement tax planning.
If you need ideas about how to make your retirement a little less stressful, we have a group of professionals at Eide Bailly who can help you define and accomplish your retirement goals using a cadre of tools like the SEP-IRA.
For more information on retirement planning for farms and ranches, please contact:
Matt Schafer, Eide Bailly Partner – Billings, MT
406-867-4187
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