A grain farmer we’ll call Owen, 63, farms 1,000 acres of grain not far from the Manitoba-United States border. He has three children ages 35, 34 and 29. The eldest, Jack, wants to take over the farm. His two siblings, who we’ll call Max and John, have town jobs and have no wish to farm.
Owen’s dilemma is how to transition the farm to Jack, obtain a $50,000 per year income when he is 65 and provide a living income or compensation to the two children who don’t want to farm. The problem is both a matter of destiny, that is, ensuring the continuation of the farm via management by Jack, and providing an equitable settlement for Max and John.
Owen sought the assistance of Colin Sabourin, a certified financial planner with Harbourfront Wealth Management in Winnipeg, Man., to work out the transfer of the farm.
We need to look at the basic finances of Owen’s farm. The farming corporation has $6.5 million in current assets, $1,013,000 in current liabilities and a net worth of $5,487,000. There are also non-farm assets including a $450,000 house, Owen’s $245,000 Registered Retirement Savings Plan (RRSP) and his $90,000 Tax-Free Savings Account (TFSA). Non-farm assets add up to $785,000. Total net worth is $6,272,000.
The best move — do an estate freeze at age 65 and then redeem $60,000 of the preferred shares in the farming corporation for the rest of Owen’s life, Sabourin suggests.
The corporation is worth $5,487,000. Assuming it grows at five per cent per year, it will be worth $6,049,420 in two years when Owen is ready to retire, Sabourin notes. He can then issue new common shares to his farming son. Any future growth of the corporation will be in his son’s hands.
In the first year of retirement, Owen can redeem $60,000 of preferred shares and do that every year, raising money taken out of the corporation by two per cent per year to pace inflation.
That process should generate annual income of $60,000, and there is $6,000 from the Canada Pension Plan and $7,380 from Old Age Security (OAS).
On an after-tax basis, that cash flow would generate $58,768 per year. There would be a $1,232 deficiency, which Owen can cover by dipping into his RRSP or TFSA, Sabourin explains.
The OAS clawback could be a problem, for it is triggered when net income rises over $79,845. The redemption of preferred shares is treated as dividend income, so there would be a loss of a few thousand dollars to the clawback. This process will leave Owen with sufficient retirement income to age 90.
The estate freeze will make it possible for Jack to avoid having to come up with cash for the buyout. Owen will continue to control his farming corporation. If eldest son Jack does not manage the farm well, Owen can step back in and resume control, Sabourin cautions.
Two years from now in 2023, farm assets before inflation adjustment would be $5,487,000. Assuming that Jack takes $60,000 out of the farm in year one of the transition and assuming two per cent inflation going forward, then the preferred shares would generate a lifetime payment sum to age 90 of $1,960,254. At 90, the farm would have undistributed value of $4,089,163, Sabourin estimates.
Add in $250,000 of personal investments and the $450,000 farm house, the total net worth for Owen’s life would be $5,089,163. A life insurance policy for $1 million Owen bought a decade ago will fund a $500,000 inheritance for each of the non-farming children. They will have to sell any preferred shares they hold back to the farming corporation, Sabourin explains. The farming child will have to buy those shares with the $1 million life insurance policy that gets paid out to the farming corporation tax-free. That money will enable the farming child to buy his siblings’ shares at $500,000 each.
With all of that done, the non-farming children will have received $1 million each, while the farming child will have inherited the $3,089,163 of preferred shares.
Is it equal and fair? The farming child is going to have $3 million of preferred shares while the two brothers are only getting $1 million each. But the farming child will have to sweat for his income, get up to feed the animals each morning and manage the farm, while the non-farming siblings get $1 million each as a passive inheritance. The $1 million per child at an assumed rate of return of five per cent per year will provide them with $50,000 per year each for life. All in all, it’s a fair, efficient plan, Sabourin concludes.
This plan looks complex, but it really is just an apportionment of life insurance payouts, tax-free, to enable the farm to continue and to provide a way to reorganize the share capital of the farm. It is open, totally in compliance with tax law and not very hard to administer once the plan is in place. Most of all, it enables Owen to treat his three sons fairly, with the farm going to Jack and a good deal of cash to his two non-farming brothers.