Illinois AgriNews - November 2007
Year-End Tax Planning
Gary J. Hoff
Department of Agricultural and Consumer Economics
University of Illinois
Due to record breaking incomes in 2007, is this the year to establish a retirement plan? Many farmers have the attitude that excess income should be invested in additional farm land. However, this may require liquidation of the land at the time of retirement to produce income sufficient to allow the retiree to maintain his accustomed standard of living. A retirement plan, on the other hand, is designed to produce cash to meet retirement needs.
The first decision is whether you want a qualified or non-qualified retirement plan. Qualified means the plan will produce a tax deduction when the contribution is made. The earnings from a qualified retirement are tax-deferred. Distributions from the qualified plan are taxable when received. There are non-qualified retirement plans available that do not provide a tax deduction at the time of contribution, but allow for non-taxable distributions of either the contributions or the contributions and earnings.
The most common qualified plans include the IRA, SEP IRA, SIMPLE, 401(k), and Keogh plans. Non-qualified plans include the Roth IRA, non-deductible IRA and Roth 401(k).
There are a number of considerations when deciding on a retirement plan. The first decision is whether you want a plan that requires contributions for your employees. Some plans prohibit discrimination and require all employees be covered. Others allow discrimination based on the length of time they have been employed, whether they are full-time or part-time, and their age. Other plans allow employee participation but do not require an employer contribution. Still others do not require any employee participation.
The second decision is whether you want a plan that requires an annual contribution or one that allows you to choose to contribute each year. Depending on the plan, contributions may be based on a fixed amount or a percentage of your net farm earnings.
The third decision is the amount you wish to contribute. Plans are available that will allow a maximum contribution in 2007 of $45,000. Other plans do not require any annual contribution.
The fourth decision is whether you want a plan that produces tax-free or taxable distributions. Distributions from the “Roth” plans are tax-free as long as certain provisions are met, such as leaving the money in the plan for at least five years. Roth plans are similar to other retirement plans in that distributions cannot be taken without penalty before age 59 ½, with certain exceptions. However, Roth plans have no minimum distribution rules after the taxpayer reaches age 70 ½. Unlike some other types of plans, the taxpayer can continue making contributions to the plan after reaching age 70 ½.
The taxpayer should consult with his accountant or financial planner to determine which plan is most appropriate for his situation.