In my upcoming session at the Farm Futures Business Summit 2016 in Saint Louis in January, we will touch on five things you need to start farm succession planning: Lifetime income, successor preparation, managed health risk, managed successor's risk, and fairness to heirs.
The first is creating lifetime income for the exiting generation.
A great place to start is to determine the amount of income you NEED in retirement. Add to that the additional income you WANT to have and you have your Retirement Income Goal.
NEEDS: Housing expenses, living expenses, insurance, medical, family gifts and celebrations, charity
WANTS: Travel, entertainment, hobbies
If your retirement income goal is $4,000 per month, that's $48,000 per year after tax. You have a few options:
Nest egg. If you have saved a nest egg in a traditional retirement account you will need to remove enough to pay income tax and still meet your income needs:
• Net goal = $48,000 per year
• Effective tax rate state and federal = 20%
• Gross distribution needed = $60,000
Rental income. Many farm retirees plan to own the land and collect rent to provide income. Cash rental income is superior to profits from the farm operation since the rental income is NOT subject to self-employment tax of $15.3%.
The projected average rental rate in Minnesota, according to the University of Minnesota Extension Service, is $210 for 2016. So living off the rent looks like this:
• Income need of $60,000
• Rental income of $200 per acre
• Acres needed to deliver the income: 300.
Modified rental income. If you want to give your successor a better deal to make it easier for her to successfully complete the transition, you might discount the rent to 75% of the county average rent. In this case:
• 75% of $200 = $150 per acre rent
• Income need of $60,000
•Acres needed to deliver the income: 400
More on retirement accounts and distribution rates
If you are going to get the income from a retirement account, the recommended distribution rate is 4% per year.
• $60,000 annual distribution
• Nest Egg size needed to sustain $60,000 distribution = $1,500,000.
You can reduce your distribution rate by using other sources of income such as:
1. Social Security Income Benefit
• Maximum at age 70 -- Roughly a 32% bonus over the Primary Income Amount
• Full benefit at full retirement age (65+ depending on your year of birth) -- Primary Income Amount is calculated based on earning credits on at least 10 years of earnings.
• Early benefits available at age 62 -- Roughly a 25% penalty off the Primary Income Amount
2. Pension income from off-farm employment
3. Passive income from other investments – rental income
• Taxable as ordinary income
• Not subject to FICA
• Will not reduce Social Security AFTER you reach Full Retirement Age
If this blog has you thinking about your own situation, get in touch with my office at [email protected].
Investing in a knowledgeable advisor and thinking about answers to key questions before putting pen to paper can make creating a farm estate plan much less complicated. Use the Penton Agriculture free report, Farm succession planning: Customizing a farm estate plan to get started on your own plan.
The opinions of Rich Dunn are not necessarily those of Farm Futures or the Penton Farm Progress Group.