One-Participant 401(k): Saving for Retirement and Reducing Taxes

Man filling out tax forms at desk
For farmers and ranchers, having investments like a retirement account can help mitigate risk. Often, retirement funds grow at a higher rate than inflation, protecting a person’s purchasing power later in life.

One-Participant 401(k): Saving for Retirement and Reducing Taxes

The adage that farmers and ranchers are often asset-rich and cash poor does indeed appear to be true! According to the United States Department of Agriculture (USDA), just forty percent of farmers contribute to a 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. This can create cash flow challenges, especially for an older generation of farm and ranch families wanting to bring the next generation into the operation and keep the business going.

For self-employed farmers and ranchers without full-time employees, the opportunity to invest in a One-Participant 401(k) plan is a way to (1) save money for retirement, (2) reduce taxable income, (3) provide the potential option to borrow from the plan. This article focuses on saving for retirement and reducing tax liability.

For farmers and ranchers, income can vary drastically from one year to the next based on weather, commodity prices, input costs, etc. When financial windfall years occur, one of the questions frequently asked by business owners is, how can tax liability be reduced for this year? Instead of purchasing a new implement for depreciation purposes, perhaps the answer could be contributing to a retirement account, such as a One-Participant 401(k).

Although many farmers and ranchers don’t ever plan on retiring from their operation, having funds invested in a retirement account may be beneficial. Some circumstances may force a person to reduce or eliminate their ability to continue to be involved in their operation. Frankly, Social Security may not be enough for a farmer or rancher to live off if they qualify. Frequently, the drive to lower taxable income leaves many farm families with meager Social Security benefits. Having some funds set aside for retirement is highly recommended by financial professionals.

The primary purpose of a One-Participant 401(k) is saving for retirement, but this retirement account comes with the added benefit of reducing tax liability. There are two ways that these accounts are “tax advantaged.” As a reminder, these plans are only available to operations run primarily by one individual and his/her spouse, with part-time employees who do not work enough to qualify as “full-time” employees (generally 500 hours for three consecutive years).

First, the current year’s tax liability can be reduced by contributing to a One-Participant 401(k). Contributions are made to these plans with pre-tax dollars. Contributing to a retirement account, such as a One-Participant 401(k), is a common “for Adjusted Gross Income” tax deduction. This account allows for larger contributions than other retirement plans because it allows sole proprietors to make contributions as the employee and employer.

Continue this article on the Center for Ag Profitability site.

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