The newest entrants to the ranks of the nouveau riche are the U.S. practitioners of one of the world’s oldest professions: farming.
The U.S. farmer is awash in new wealth. Since 2008, farm asset values are up 49%, farm debt has risen by only 28% and farmland cash markets continued to see gains related to strong crop prices in 2013.
This type of wealth is not easily managed, however, because it is often illiquid and geographically concentrated. The wealthy farmer may have multiple agribusiness operations extending beyond the field, but the main wealth pipeline is still coming from one region and one industry—agriculture.
Yet the opportunity to manage farming wealth is compelling. Successful farmers are familiar with risk and usually savvy about agricultural finance, but as a group, they are relatively new to working with wealth management institutions.
Thus lies the challenge: Farmers have historically had an ambivalent relationship with institutions. They are sometimes distrustful of the government, yet highly influenced by government supports, services and policies. They are wary of banks—remember what happened to family farms during the Great Depression?—yet they are active users of credit. And, although traditionally not familiar with high-net-worth financial services, they are masters at working with commodities and futures.
In the current economy, farmers are seeing their balance sheets rise at dizzying speed as money flies into commodity and farmland investments. Yet because even the very wealthy farmer typically lives in a rural area, he typically doesn’t have the opportunity to lunch with a broker or drop by the downtown law firm for a chat.
The Advisor’s Challenge
Advisors to farmers must be prepared to display empathy and patience. Embedded in a livelihood that conducts business season by season, farmers typically are not keen on striking “quick deals.”
Advisors also need to know about farming and the challenges that come along with farming operations. One of the big issues for many wealthy farmers, for example, is tax management. With soybean and corn farmland going for more than $10,000 per acre, estate and capital gains taxes are pressing issues for the wealthy farmer, most of whose assets are illiquid. The liquidity challenge is particularly acute because so many farmers want to keep the farm in the family. For many farmers, their business exit plan is to slow down or stop farming, but not sell the farm to outsiders for profit.
Dealing With Wealth
As we explore the special planning needs of farming families, consider this real-life case I recently encountered:
A widowed father, who we’ll call Mr. Smith, died, leaving an estate that included a vast track of prime farmland, new farm equipment and cash. His will provided that each of his four adult children should share equally in the estate. Two of the children had moved to the city and had no interest in running the farm, but wanted to see the century-old operation continue. Two of the children remained in the area and were interested in obtaining the land for their own farming operations.
The first hurdle was that the farm was held as a sole proprietorship. The child appointed as executor was quickly thrust into the unwinnable chore of deciding which child was assigned which assets, including the farmland. It was a tricky task because not all acres yield the same profit.
Estate taxes were another issue. The IRS valued the farmland at $11,000 per acre and assessed the estate a $2.2 million estate tax.
Finally, when the two city children tried to sell their land and equipment to the other two children, a dispute arose over valuations. As a result, some of the land was sold to pay the estate tax and the city children put their land and assets up for sale at auction.
As a result, the family farming operation no longer exists and the siblings and in-laws involved in the dispute have become emotionally distant.
But the family and the farming operation could have survived if Mr. Smith had planned ahead.
A basic model for helping prosperous farmers such as Mr. Smith manage wealth while preparing for the continuation of the family farm starts with four steps:
Step 1 – Survival: The typical farmer will not proceed with long-term financial and estate planning until he’s comfortable that the family and the farm will survive financially. Memories of the Great Depression and the farming crisis of the 1980s run deep in farming families; farmers are cautious with wealth and hesitant to give up control over assets. Remember, “saving for a rainy day” is more than a casual adage to people whose business is dependent upon the weather.
To ensure financial survival, the advisor team should first secure a valuation of all real and personal assets. This helps size up the challenge from an estate planning and wealth management standpoint. Equally important, however, is to assess income and expenses for the family and farm. Even with wealthy farmers, a bedrock concern is not outliving assets. Many farmers do not have adequate health insurance, and access to specialists can be difficult in remote areas. Health insurance exchanges may need to be sorted through before you invest disposable assets.
To ensure family survival, the advisors need to ask tough questions. Do any of the children want to run the farming operation? If the answer is yes, do the children agree on who should be in charge? How do the children’s spouses feel about continuing the farm? The advisor who can break through these emotional issues can then break open the piggy bank and get a financial plan in operation.
Step 2 — Tax And Legal Challenges: Like any business, farming involves a lot of blocking and tackling from a tax and legal standpoint. Farms are capital-intensive, typically subject to debt and highly volatile in terms of revenue. Mr. Smith’s farm, for example, was subject to a state estate tax in addition to a federal tax. With planning, several steps could have been taken to mitigate the issues that wrecked this operation:
• The acreage and farm implements could have been put into a separate entity, such as an LLC, so that the children would have been given business interests rather than acres and tractors. This would have made the transference of wealth far simpler.
• Life insurance could have been purchased and put into an irrevocable life insurance trust so that liquid assets would be available to pay estate taxes.
• A valuation method could have been described in the will so as to avoid disputes over the value of the farming assets.
• An exit plan could have been created to ensure a smooth transfer of the century-old farm to the next generation.
Step 3 — Exit Planning: It is futile to attempt wealth management and estate planning before a succession strategy is determined. Most farms have wealth concentrated in the farm itself, and little can happen with that wealth until the business is dealt with.
In the case of Mr. Smith, a succession plan could have ensured continuation of the farming operation and fair treatment of all four siblings, with two important components:
• An exit plan could have been created during the farmer’s lifetime for the farm to go to the two children involved in farming. Without giving up control during his lifetime, Mr. Smith could have put much of the farm operation in the hands of his sons involved in farming either through gift or sale. The farmer could have retained voting control and the children’s share of the farm would have been valued at a discount. The shares could have then been gifted outright or through a grantor retained annuity trust (GRAT). The low-interest-rate environment would have made it possible to move business wealth to the next generation through a sale, without necessitating an excessive cash flow burden on the beneficiaries. The business profits might well have generated enough to carry the debt service on discounted shares in the farming operation.
• The two children not involved in the farm could have had their inheritance equalized through life insurance and other assets. While the farmer was still insurable, it would have been possible to expend a small percent of assets each year in insurance premiums to create a cash fund for the children not involved in the business. Using traditional estate planning techniques, this money could have been moved out of the farmer’s taxable asset base, free of gift and estate taxes.
Step 4 — Wealth Management: Many farmers are simply unsure of what to do with their newfound wealth. A number of farms have too much equipment and infrastructure because farmers weren’t aware of any other ways to reinvest profits. Farmers are familiar with the concept of hedging because they use it in farming. But with a wealth manager as a guide, they can learn how to use diversification in areas outside of agriculture.
Mr. Smith, for example, could have avoided purchasing unneeded equipment and converted some of his illiquid assets into investable and expendable wealth. This would potentially have saved taxes and helped fund his succession plan.
The average farmer retires at age 62, but many remain active on their farms or ranches for years longer. Moreover, a farm is five times more likely than a non-agricultural business to be passed on to a succeeding generation. Add to this the enormous wealth being created by top-tier farms and the need for wealth management is clear. Farming wealth may be nouveau, but planning solutions are time-tested.
Steve Parrish is advanced solutions director at Principal Financial Group.
