The recent tax deadline can be a good benchmark for the past year. Did you pay more tax than you want? Did you make less money than you thought? How are you fixed for cash flow?
Many farm businesses do a good job to minimize the yearly taxes. But, sometimes the focus is on less tax and not on moving forward toward goals.
If you are serious about transitioning out of the business, it might make sense to recognize more income now, fund a retirement plan, and even *gasp* pay more tax this year in order to set the stage for the transition to the next generation down the road.
Here is why:
If you are 55 and want to transfer the business to the next generation by the time you are 70, you have 15 years. I suggest that your transition will be easier for everybody if the senior generation enters the transition years with $1 million dollars in savings that's not real assets on the farm.
Why, you ask?
If you have off-farm savings then two good things are possible when you retire:
1) You need less income from any farmland you own in retirement. You can charge less-than-market rent, at least for a while, to help the junior generation get established.
2) To build up the savings you will recognize more taxable income over a period of years. That means *gasp* FICA tax, but it also means credits toward a Social Security retirement benefit. Both spouses can get a monthly check for AS LONG AS YOU LIVE. Which is a handy retirement income tool.
But how is this possible, you ask?
It's easy, as long as the farm business has healthy cash flow.
If both spouses contribute to the farm business, they can each defer $54,000 per year into a retirement plan. The business will have to recognize only some of this as compensation and pay FICA tax on that amount. The two spouses show it ALL as deferred compensation and pay no tax.
If both partners save $54,000 per year, a total of $108,000, for 10 years that equals $1,080,000 of retirement contributions. This assumes you save the money into a savings vehicle with zero growth.
If you think you could average 5% growth per year over the next 20 years you could reduce the time to 8 years.
If you have $1M in savings, and prudently invested, you may be able to remove $40,000 per year in retirement and have the money last forever.
Between $40,000 income from savings and two Social Security checks, you have really reduced the need for the junior generation to subsidize your retirement.
Maybe it's worth a discussion with your fee-only, fiduciary financial planner. That person is required to keep your interest first and will help you evaluate how this idea fits in your Legacy Plan.
If this blog has got you thinking about your own situation, get in touch with my office (firstname.lastname@example.org).
The opinions of the author are not necessarily those of Farm Futures or Penton Agriculture.