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Retirement Planning for Farm Families: A Balancing Act. Retirement Planning. 2 Views Being “Put out to pasture” Beginning a new phase of life! Main Focus of Retirement Planning Determining what you want to do in retirement Determining how you will finance your retirement .

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Retirement Planning for Farm Families: A Balancing Act

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Retirement Planning for Farm Families: A Balancing Act


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Retirement Planning

  • 2 Views

    • Being “Put out to pasture”

    • Beginning a new phase of life!

  • Main Focus of Retirement Planning

    • Determining what you want to do in retirement

    • Determining how you will finance your retirement


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Questions to Ask Yourself

  • What do you want to do in retirement?

  • How many people will you be supporting in your retirement?

  • What financial obligations (debts) will you have in retirement?

  • How long do you expect to live?

  • How is your health? Your spouse’s health?

  • What is your annual cost of living?

  • How long will your retirement savings last?


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Main Sources of Retirement Income

  • Sale or lease of farm/business assets

  • Continued work during retirement

  • Social Security

    • A supplement to your retirement savings

      • Not meant to be a complete retirement program

    • Provides maximum of $20,000/year currently Retirement investments (portfolio)

  • Individual retirement savings

    • IRAs, CDs

  • Employer-sponsored retirement plans & pensions

    • SEPs, Keoghs, 401(k), 403(b), 457, etc.


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Start Planning Before You Retire

  • The earlier you start, the better!!!

    • Time value of money!

  • Over 50% of US population age 18-34 have not started saving for retirement!

  • More than 25% between age 35-54 have not started!

  • Over 33% of US adults over age 65 have no income from savings!


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Social Security Family BenefitsAverages for two most recent years

  • 1996

    • Average monthly benefit per family $1,255.58

    • Average beneficiaries per family, 2

    • Average benefit per person, $627.79

  • 1997

    • Average monthly benefit per family, $1,268.81

    • Average beneficiaries per family, 2

    • Average benefit per person, $634.41


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Why is Investing for Retirement Important?

  • Consumption does not change significantly during retirement

    • Typically need 70-80 % of your pre-retirement income

      • Farm families may need over 100% of pre-retirement income!

    • Don’t forget about inflation!

  • Income from work falls drastically in retirement

  • Social Security does not meet most of your monetary needs during retirement

    • Usually less than 50% of needed income is provided


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Why is Retirement Planning Important?

  • You’ve been farming for the past 40 years

    • Just turned 65

    • Invested all profits back into the farm ever year

    • Net Worth of $500,000

    • Expected living expense during retirement of $40,000/yr

  • Facts

    • Average 65-year old male has 17-year life expectancy!

    • Average 65-year old female has 24-year life expectancy!

    • If you sell/lease the farm assets, deferred taxes may take up to 27% of your equity!

    • Annual inflation of 4% cuts purchasing power in half every 18 years!


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Sell the Farm?

  • Deferred taxes reduce your net worth by 27%

    • $500,000 has quickly become $365,000

  • Invest the $365,000 in assets earning 5%

    • Relatively “safe” investment

  • Ignoring inflation and Social Security benefits:

    • Your net worth will provide $41,700/yr for only 12 years

  • With inflation

    • Net worth provides $41,700/yr for only 10 years

  • If you expect a 20-year retirement

    • Net worth only provides $29,200/yr


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How Can Retirement Planning Help?

  • Reduce tax liability (pre-retirement)

  • Obtain interest-free loan from Uncle Sam

    • Through deferred taxes

  • Increase earnings by compounding tax-deferred dollars

  • Reduce your dependence on Social Security

  • Reduce the need to sell/lease your business assets

  • Diversify your investment portfolio

  • Provide for a more secure retirement


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Steps to a Successful Retirement

  • Set definite, but realistic retirement goals

  • Outline your plans in writing

  • Assemble your financial support team

    • Spouse and immediate family

    • Certified financial planner

    • Accountant

    • Insurance Agent

    • Estate Planner/Attorney

    • Banker/lender

  • Put your retirement plan into action early

  • Review and update your plan periodically


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Enemies of Retirement Planning

  • Lack of Goals

  • Inflation

  • Procrastination

  • Ignorance

  • Excessive Debt

  • Poor Investments

  • Taxes

  • Instant Gratification

    • The “Now” Generation


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Effects of Inflation 4% over 30 years

  • $.60 cup of coffee will cost $1.95

  • $12 restaurant meal will cost $38.92

  • $100 hotel room will be $324.00

  • $25,000 pick-up will cost only $81,085


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Main Retirement Plans

  • Individual Retirement Account (IRA)

  • Simplified Employee Pension Plan (SEP)

    • Also called SEP-IRA

  • ROTH IRA


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Common Factors of Retirement Accounts

  • Tax advantages

    • Earnings are not taxed until withdrawn!

    • Contributions are often tax-deductible or from pre-tax income (not subject to income tax)

  • Penalties for early withdrawal

    • Early withdrawal is before age 59 1/2

    • Federal penalty of 10%, plus state penalty, plus ordinary income tax on the amount withdrawn

  • Control over your retirement investments

    • You typically control the investments yourself

    • Allows the selection of stocks, bonds, mutual funds, etc.


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How do retirement plans differ?

  • Participant eligibility

    • Who can participate?

  • Administrative responsibilities

    • Important for business owners/managers to know!

  • Allowable contribution limits

    • Some plans have low contribution limits

  • Investment vehicle options

    • What can you invest in?

  • Tax consequences

    • Tax-deductible, tax-deferral, tax-free, taxable


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Individual Retirement Account (IRA)

  • A personal retirement savings plan

  • IRAs may be set up with banks, mutual fund companies, or similar investment organizations

    • Can invest in CDs, mutual funds, stocks, bonds, etc.

  • Maximum contribution of up to $2,000/year

    • Lesser of 100% of earned income or $2,000

    • Married couples have $4,000 per year maximum

  • Contributions may be tax-deductible

    • Depends on whether you or your spouse is covered by a qualified retirement plan at work

      • Tax-deduction is phased out for higher income levels


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Individual Retirement Account (IRA)

  • Keep separate IRAs for tax-deductible contributions and non-deductible contributions

    • Eases the “income tax headache” when you begin to withdraw funds from the account

  • Cannot make contributions after age 70 1/2

  • Must begin to withdraw funds at age 70 1/2

  • Penalty for withdrawing funds before age 59 1/2

    • Exceptions - disability, medical emergency, etc.

  • All earnings grow tax-deferred until withdrawn

    • Taxed at your marginal income tax rate during retirement


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IRA Example

  • You earn $65,000/year, non-working spouse

    • 28% tax bracket Federal, 7% State

    • IRA Contributions of $2,000/year per person

      • Reduces income taxes by $1,400

      • Earnings are not taxed until withdrawn from IRA

    • After 40 years (10%) IRAs = $1,770,000

      • Annual withdrawals are taxed at ordinary income tax rate

    • Invest in taxable account = $605,500 (after-tax)

      • $2,880/year, 28% MTB, 40 years, 10% pre-tax return

    • BE Average Tax Rate = 66%


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Simplified Employee Pension Plan (SEP or SEP-IRA)

  • For self-employed owners of small businesses and their qualified employees

    • Employees must meet certain guidelines

      • Age, time of employment and income earned

  • Simple

    • Little paper work is required

    • Simply set up an Individual Retirement Account

  • Generally, contributions are made by the employer

    • These contributions are tax-deductible for the employer


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The Simplified Employee Pension Plan (SEP or SEP-IRA)

  • Contribution limit

    • Up to 15% of the employee’s compensation (salaries, tips...) to a maximum amount of $24,000 per year

    • Employers must contribute the same percentage to their employees’ IRA as they do to their own IRA

  • For tax purposes, contributions to the SEP-IRA are excluded from the employee’s taxable income

    • Subject to Social Security & Medicare taxes, but not income taxes

  • SEPs have replaced Keogh Plans


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SEP Example

  • Earn $30,000 of self-employed income

    • Annual contribution of about $3,912

      • 13.04% for Employer = 15% for Employees

    • Reduces your income taxes by $1,095

    • Earnings grow tax-deferred until withdrawn

    • Still eligible for Individual IRA and Spousal IRA!

      • $4,000/year combined, $1,120 additional tax savings

    • After 40 years (10%) IRA and SEP = $3,502,000!!

      • Taxed as ordinary income upon withdrawal


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Recent Information Regarding IRAs

  • The “Roth-IRA”

    • Will take effect in 1998

    • Provides tax advantages when money is withdrawn

    • Contributions to the Roth-IRA are not tax-deductible

    • Earnings from the account are not taxed as long as certain requirements are met

    • May withdraw $10,000 before age 59 1/2 without penalty

      • After 5 years of participation

      • Withdrawal must be used to buy a first home

    • Provides great tax advantage to those who are not able to deduct contributions to their individual IRAs


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Tips for Retirement Investing

  • Research the retirement investment vehicles available to you

    • Determine the plans for which you are eligible

  • Determine the amount of income that you will need during your retirement

  • Determine the investment options which will meet your goals for retirement income

  • Keep informed on new changes! Ask Questions!


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Game Plan for Retirement Investing

  • Establish Your Goals:

    • Determine the annual income you want to have during your retirement

      • In today’s dollars

      • Annual living expenses include your travel, hobbies, health, etc.

      • Typically 60-80% of pre-retirement income

        • Or 80-100% of pre-retirement living expenses

    • Estimate annual income from Social Security & Pensions

  • Know Your Available Resources:

    • Current amount of savings

    • Equity in your home and/or business


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Game Plan for Retirement Investing

  • Make Assumptions:

    • How many years until you retire?

    • How long will you live in retirement?

    • What is the average nominal rate of inflation?

    • What average nominal rate of return do you expect from your investments over time?

  • Make Your Strategies:

    • Determine the amount you need to save every year to meet your retirement goals


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Retirement Planning Example

  • Paul and Karen are 35 years old

    • Average annual income of $40,000

    • Estimate $35,000/year living expenses during retirement

    • 30 years to retirement, 25 years in retirement

    • Average annual inflation rate = 4%

    • Average return on investments = 8%

    • Current savings of $10,000

    • No pension from job

  • How much do they need to save per year to meet their retirement goals?


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