‘Begin with the end in mind’

Self-employment and choosing an advisor

by Sally Colby

Paula Ledney uses this Stephen Covey quote to emphasize the importance of setting goals when farm business owners work through retirement planning.

Ledney, who serves as the education program associate and financial analyst in business, energy and community vitality at Penn State, opens by defining a farm. “The term farm includes stock, dairy, poultry, fruit, fur-bearing animals and truck farms, plantations, ranches, nurseries, ranges, greenhouses used for the raising of agricultural or horticultural commodities and orchards or woodlands,” she said. “A farmer is a person who is engaged in farming and generally has a profit motive when operating the farm business.”

These definitions are important because farmers receive special tax benefits, including the ability to carry over and deduct net operating losses, the ability to deduct ordinary and necessary expenses and the ability to exclude certain receipts such as conservation payments, from their taxable income. “All of these benefits reduce taxable income and generally, the amount of your yearly taxable income is one of the major factors in determining how much you can contribute to a retirement plan on a yearly basis,” said Ledney.

Since farmers are considered self-employed, they’re eligible to use certain retirement plans. A person is recognized as self-employed by how their business is organized. “If you’re a sole proprietorship, you are an unincorporated business owned by one person,” Ledney said. “A partnership exists when two or more persons associate to conduct business. Each contributes money, property, labor or skills and expects to share in the profits and losses. A corporation is a legal entity authorized by the state to operate under the rules of its charter. A corporation is taxed as an entity rather than its owners being taxed as individuals and provides only limited liability. Each owner’s loss is limited to his or her investment.”

Another way to determine self-employment is by employee status. A person is an employee if they are under the direct control of the employer. In contrast, a self-employed person earns income directly from their own business and does not have federal income tax and FICA payments withheld from the paycheck, does not complete a W-4 for an employer and is not covered by employer liability insurance or workers’ compensation and also is responsible for their own work schedule.

Farmers are in a unique situation when it comes to retirement planning. Many self-employed farmers have no access to traditional retirement plans, and it’s easy to put off savings when there’s no easily accessible plan with reminders to participate along with education about savings and investing.

Many farmers tend to invest in farm business assets instead of saving and investing in stand-alone retirement plans. This can be a problem because farming is inherently risky and influenced by weather, trade issues, currency fluctuations and political strife, both domestically and globally. “While investing can also be risky, there are ways to diversify your holdings, usually with just a click of a button, and these holdings are easily liquidated,” said Ledney.

“Land, buildings, equipment and livestock are not so easily changed. Selling one component of your farm business could negatively impact the entire business.”

Another confounding factor in retirement planning is farmers’ desire to keep the farm in the family. However, Ledney said passing on the farm begins with ensuring a viable business for the next generation, which may not be possible if it’s necessary to sell assets to fund retirement goals and living expenses. “Ideally, you want to do both – pass on the farm as a viable business and enjoy the retirement lifestyle you desire,” she said.

Although individuals can create their own retirement plans, Ledney suggested using a professional. Ask fellow farmers who they use for financial planning and what they use them for. Many trade organizations such as Farm Bureau and agricultural lenders have accountants on staff who can direct farmers to professionals who are familiar with farming.

An important term to understand prior to starting a financial plan is fiduciary: an individual who’s ethically bound to act in another person’s best interest. This obligation eliminates conflict of interest concerns and ideally results in more trustworthy advice from an advisor.

There is no standard definition for a financial planner – anyone can call themselves a planner so Ledney cautioned farmers to be careful. If you’re receiving advice on investments, check to see if the person is a registered investment advisor (RIA) – they are required to act as a fiduciary.

Another important qualification to look for: Certified Financial Planner (CFP). To become a CFP, the person must hold a bachelor’s degree, complete an extensive certification program, pass the CFP exam and accumulate 6,000 hours of experience as well as meet ethics requirements before they can use the CFP designation.

An RIA must act as a fiduciary and is legally allowed to provide advice on investment vehicles such as stocks, bonds, mutual funds and annuities. An RIA has completed training and exams offered through the Securities and Exchange Commission (SEC). In contrast, broker-dealers and insurance agents are only required to fulfill a suitability obligation. This means the products they offer must be suitable, but dealers and agents are not required to put clients’ interests before their own. To be sure the advisor is acting in your best interest and not just selling a product, Ledney suggested asking the planner whether they are required to be a fiduciary, and make a decision based on that information.

Ledney said the way in which investment advisors are compensated has changed due to the industry undergoing significant changes, including robo advisors, which are computer-generated, and DIY planning. Planners recognize that with the internet and computer-assisted retirement options, they can’t charge as much as in the past. The result is a shift toward a model of flat fee, retainer fee and hourly fee.

Most models are considered “advice only.” “In some cases, planners cannot receive a commission on any product they recommend if they put themselves out at ‘advice only,’” said Ledney. “You can pay for advice or pay for products and services.” She added that do-it-yourselfers may be satisfied with periodic advice to ensure their own ideas are valid and strategic. For those who are not interested in managing on their own, the traditional model of “assets under management” means your advisor receives a percentage fee of the assets they’re managing.

If an advisor is recommended, check their background and experience online through BrokerCheck. Another tool, the Investment Advisor Public Disclosure database, is available from the SEC.

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