These are the financial issues specific to farm and ranch owners that can impact their succession plans.
Emotions can run high when transitioning a family-owned business to new owners. But when it comes to farms and ranches, emotional ties to the land can run even deeper.
“For many farmers and ranchers, the land has been in the family for an extended period of time,” says Carol Goetsch, senior product manager of insurance and annuities for RBC Wealth Management–U.S. “They often lack the ability to step away from something and to contemplate their succession plan.”
Goetsch has experienced that situation firsthand. After her mother passed away, she and her siblings inherited an 80-acre farm in Wisconsin, which had been in the family since the late 1800s.
“When she passed away, my siblings and I felt that each of us deserved one-third of the farm,” Goetsch says. “My mother wanted my husband and I to have more, given the time and money we spent caring for her … but her written will left it to all of us equally.”
Goetsch, who bought out her siblings’ share of the farm, says this is an example of why succession planning—in writing—is so important, and why it should be done sooner, rather than later. A business succession plan, an estate plan and funding for retirement should be addressed years before a farmer or rancher reaches retirement age, she explains.
“Ideally, you want to make a plan three to five years or more before you begin to transition your business,” Goetsch says.
Angie O’Leary, head of Wealth Planning for RBC Wealth Management–U.S., faced a similar situation as Goetsch with her family farm in Wisconsin, which is now run by her brother along with her nephew, who would be the fifth generation of her family to operate it.
“My father changed his estate plan after my mother passed away, and gave significantly more to one of my brothers,” O’Leary says. “The smaller portion was split four ways, between me and my other siblings. Because the change was made secretly, there was no way to plan for the final settlement, which included having to sell our portion of the farm.”
That sale came with a substantial capital gains tax bill, she adds. The emotions involved with the sale, coupled with the loss of her father, put the family into an emotional tailspin.
A good estate plan would have equalized the inheritance, eliminated some of the tax consequences on the family and avoided family strife, O’Leary says.
Additionally, estate planning can also help a farmer prepare financially for retirement. O’Leary’s father’s retirement plan, like that of many farmers and ranchers, was to work until he passed away. However, that approach doesn’t leave them with much in the way of retirement assets and is often dependent on the unpredictable income of the farm.
“Farmers, like most business owners, tend to put most of their extra savings back into their business,” says O’Leary. “They don’t typically have a big retirement account or other assets to rely on in retirement. They also tend to shy away from life insurance, a key tool to helping with estate equalization.”
According to the United States Department of Agriculture (USDA), just seven percent of farmers contribute to a traditional retirement plan. And because many farmers and ranchers invest profits in their business rather than take a high salary, they show little income on their tax returns. This means they will have paid less into Social Security and their benefits will be lower when they retire, Goetsch says.
“Farmers and ranchers are typically asset rich and cash poor,” adds Dean Deutz, a private wealth consultant for RBC Wealth Management–U.S.
As farmers and ranchers look ahead to a possible retirement, a critical component of their planning is identifying the potential successor or successors of their business. This can be complicated in family businesses involving the children, as parents are left to grapple with the fundamental concerns of whether their child is ready and capable of taking over the business.
Parents also have to consider the emotional issues of fairness in leaving an inheritance to their children. For example, how can parents recognize any contributions made by a child involved with the business, while also leaving a “fair” inheritance to their non-business heirs? This can be complicated even further if the family’s net worth is mostly in business assets.
Regardless of what parents decide, it’s important to discuss it thoroughly with all of the children to keep peace in the family, Goetsch says.
If there are no children or none who want the farm, the options are to hire someone to run it, lease the land to someone who will run it, or sell it, Goetsch says. The owner will need to evaluate whether the revenue would be sufficient for retirement in any of these scenarios.
The next step is to determine how to transition the business to a family member or an outsider, such as through an installment plan or a gift, O’Leary says.
There are several tools that can be used in succession planning, such as a buy-sell agreement with a life insurance death benefit.
“With a buy-sell agreement, the person taking over can purchase the property over time at a reduced market rate, and then, with a life insurance component, buy out other heirs if necessary,” O’Leary says.
Installment plans can also be negotiated for an ongoing source of income for the owner and to make it easier financially for the buyers, she adds.
Many farmers tend to be frugal and need little income to sustain themselves in retirement, especially if they intend to stay on their farm. Even so, it’s smart to plan for a change in lifestyle with a retirement account.
“You need to start planning with an understanding of what you want to do in retirement, such as travel or play golf,” O’Leary says. “You need to plan for daily expenses and medical bills, too. One big difference is that many farmers’ living expenses—such as gas for their car or heating—are business costs, not personal costs. That will change if you sell or gift the business to someone else, so you need to plan for those expenses.”
Business owners, including farmers, can open an IRA to save for retirement and defer taxes, then pay taxes when they withdraw the funds, Goetsch says.
“A financial advisor can advise them on retirement funding options such as an annuity contract for guaranteed income or investments,” Goetsch says. “The important thing is to take a holistic, individualized approach and explore all potential scenarios.”
Another retirement consideration for aging farmers and ranchers is housing, since most of them live on their property. If the land and business are sold, they may want to create a trust so they can stay in the house, or negotiate to live in it until they pass away, O’Leary says.
Selling a parcel of land is one way to generate retirement income, but it can come with a large tax bill. Instead, one option is for the parents to keep the land and rent the business to their kids, or to someone else, as a source of retirement income.
“Renting the land to someone who wants to farm it or manage the cattle is usually a better option than selling it, because of the tax consequences,” Deutz says. “A huge percentage of land in Iowa, for example, is owned by someone who lives out of state, often a farmer’s widow, on the proceeds from the rental.”
For farmers without children or who have children who don’t want the farm, a charitable remainder trust can be a good retirement tool, according to Deutz.
“They can place highly depreciated or appreciated farm assets in the trust and receive a lifetime retirement income stream while spreading the taxation out over a long period of time, versus paying large up-front income tax,” Deutz explains.
When planning for the future, farmers and ranchers have assets other than the land that will need to be protected or passed on to heirs. These can include additional buildings, farm equipment, grape vines, almond trees, other crops and cattle—all assets that need to be protected and insured.
“A life insurance death benefit can be a great way to equalize an inheritance,” O’Leary says. “For example, if my father wanted to give a $1 million farm to my brother, he could have purchased a life insurance policy for $4 million that could have been split equally among me and my other siblings.”
A life insurance death benefit can also be used to pay off debts on the farm, such as a mortgage or an equipment loan, Goetsch explains.
In the past few years, farms and ranches have often doubled in value, according to O’Leary, with properties of 40 to 50 acres commanding $2 million or more. With so much at stake, thorough planning is critical. Landowners should carefully consider the impacts and consequences of any decision, and surround themselves with a team of professionals to help them through the process.
“Working with a financial advisor and an estate planner can help owners make sure their wishes for their business, their land and their heirs are realized,” says O’Leary.
RBC Wealth Management does not provide tax or legal advice. All decisions regarding the tax or legal implications of your investments should be made in consultation with your independent tax or legal advisor.
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