In south central Manitoba, a farming couple we’ll call Jorg, 59, and his wife, who we’ll call Carole, 57, want to retire. Their 480-acre mixed cattle and grain operation has not been very profitable for many years. To keep the farm going, they have had off-farm jobs, diverting their income to the operation. Now, nearing their 60s, they would like to hand the farm over to their sons, ages 25 and 32. The boys would love to take over the farm, but they cannot afford to buy the farm from the parents nor can the parents afford to give them the farm. Their off-farm investments are modest — just $52,500 in RRSPs and the farm home which is included in the estimated $860,000 value of the farm and its buildings.
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There is a deal on the table. A neighbouring farmer has a full-time job for Jorg at $30,000 a year. The neighbour would buy 160 of Jorg and Carole’s 480 acres for $250,000 and rent back to 60 acres of pasture for $1 per year. As well, the neighbour would rent the adjacent 160 acres that Jorg owns for $11,200 per year with an option to purchase that quarter for $300,000 in six years when Jorg reaches 65. The neighbour has expressed an interest in buying the whole farm but the offer has so far not gotten much attention from the couple.
Reviewing the case, Don Forbes and Erik Forbes of Forbes Wealth Management Ltd. of Carberry, Man., suggest that the deal could work. Both Jorg and Carole are eligible for the qualified farmland capital gains exemption. If the farmland market value is estimated at $860,000, far more than it actually is, and the book value, $144,000, is deducted, the remaining value, $716,000 will easily be offset by the exemption. If sales of parcels are staggered, it is likely that no income tax will be paid, Don Forbes notes.
The plan
The plan should therefore be to sell 160 acres for the $250,000 offered and use the proceeds to open and fully fund Tax-Free Savings Accounts that have a present limit of $52,000 per person and the invest the balance in a non-registered investment account. Carol and Jorg have abundant RRSP space, but their income would make such investment tax-inefficient.
Next move: rent the remaining 160 cultivated acres for $11,200 a year until retirement at 65. If the neighbours are willing to purchase all of their remaining land for $480,000, that offer ought to be given very serious consideration. If conservatively invested at six per cent before inflation, it would generate $28,800 per year before tax. In this friendly deal, the farm home, which is not part of the contemplated sale, would remain the property of Carole and Jorg.
Jorg has $7,500 in his RRSP. In six years to his age 65 with a six per cent annual return, it will grow to about $10,000. Carole has $45,000 in her RRSP. In the next six years, assuming she retires and converts to a RRIF at her age 63 when Jorg is 65, it would have an approximate value of $56,000. She can start taking RRIF payments of $2,000 a year with no tax. When she is 67, she can raise her RRIF payments to $4,000 a year. The extra $2,000 RRIF credit can be transferred to Jorg’s return. The $2,000 and then $4,000 RRIF payments will last into the couple’s 90s, though the sums to be paid will be very little after about 20 years, Erik Forbes estimates.
When both partners have reached 65, they can have retirement income of as much as $28,800 with $6,240 from the maximum TFSA investments at $52,000 each, two Old Age Security payments of $6,942 each at 2017 rates, and modest payments from CPP accounts of $3,000 per year for Jorg and $4,500 a year for Carole with a two year or 14.4 per cent discount for starting payments two years before she is 65.Their total incomes before tax will be $66,664. They would each pay about $4,500 income tax, with no tax on the TFSA payouts. Their net after-tax income would then be $57,664.
Sticking to the plan
This is a best-case scenario. Jorg and Carole have to work to 65 and 63, respectively. They will have to obtain solid investment returns from all their financial assets. There will be no farm assets transferred to their sons, though the sons might design a work-to-own plan with the neighbour who buys the farm.
The five years interim between the plan and the sale of the farm would have to be documented with a penalty for each party if the deal is abandoned. Moreover, obtaining six per cent a year from financial assets, which would really be about four per cent after inflation, will take careful selection of conservatively chosen stocks that pay dependable dividends of 3.5 to 5.5 per cent with the underlying shares rising at a few per cent a year.
The assets to be chosen, perhaps with the aid of a financial planner, should be large cap shares of major Canadian corporations. “Large cap” companies are those that are well known on the market. It’s essential that they be Canadian so they can make use of the dividend tax credit. At the income level Jorg and Carole will have, the tax credit, which puffs up the bottom line of taxable income, will not expose them to the OAS clawback which begins at about $74,000 each of personal income.
Large cap stocks which fit the bill would include chartered banks that pay dividends in range of 3.5 to 4.2 per cent, major utilities that pay dividends of as much as 4.5 to 5.5 per cent, and telecommunications firms which pay dividends in a range of 4.5 to 5.5 per cent.
The couple could skip stock selection and instead buy an income-focused exchange traded fund with yields in the range they require. These ETFs have management expense ratios of less than 0.5 per cent a year and some even lower. Each ETF has its quirks of stock selection, so the couple could buy a few and avoid the magnifying glass issues of ratios of banks to utilities make each income ETF a little different from the competition.
“This plan will keep the couple in the lifestyle they know with little financial risk,” Forbes explains. “It requires that they keep working until they can take OAS. Jorg has to work to 65 to get his CPP in full and Carole, retiring at 63, will take a cut of 7.2 per cent per year in her CPP. But the sacrifice is small. In any event, CPP and OAS are life annuities and the operative word is “life.”
There are potential variations in the plan, including selling most of the 480 acres to the neighbour and retaining pasture for rental or a few acres for a large garden. Moreover, the sale document could be written to allow a buyout or a partial buy-in to the neighbour’s operation by the sons if, in the next five years, they can accumulate enough money to make it work.
“This is a survival plan for Jorg and Carole,” Erik Forbes explains. “It will work, it has some flexibility, it provides a modest retirement income, and it can allow the sons to buy in if they can get the money. For Jorg and Carole, it is a good deal.”
