Retirement Planning for Farm Families: A Balancing Act

1. Retirement Planning for Farm Families: A Balancing Act

2. 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

3. 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?

4. 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.

5. 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!

6. 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

7. 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

8. 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!

9. 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

10. 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

11. 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

12. Enemies of Retirement Planning • Lack of Goals • Inflation • Procrastination • Ignorance • Excessive Debt • Poor Investments • Taxes • Instant Gratification • The “Now” Generation

13. 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

14. Main Retirement Plans • Individual Retirement Account (IRA) • Simplified Employee Pension Plan (SEP) • Also called SEP-IRA • ROTH IRA

15. 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.

16. 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

17. 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

18. 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

19. 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%

20. 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

21. 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

22. 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

23. 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

24. 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!

25. 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

26. 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

27. 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?