Fred, as we’ll call him, has farmed in central Manitoba for four decades, often adding to farm income by working for his neighbours. Over time, he has sold off parcels of his operation — once 480 acres — and is now down to 160 acres. He uses his land for producing hay, custom grazing and feeding his own herd of cows which varies from 50 to 200 head, depending on the price of calves and what he thinks he can get for cows in spring. Now age 61, he looks back at what he has built, what it will take to retire, and how to structure his business to make retirement feasible.
Fred’s operation has had a bumpy ride. In 2003, he was devastated by the BSE crisis. Feed was too expensive that winter, so he sold his entire herd at a $100,000 loss.
With fewer cows to feed, he decided to sell 320 acres of land in 2004. The decision was tough, for he could have sold his RRSPs to get cash to keep the herd going. Sale of RRSP assets would have attracted tax. Selling the cows at a loss was his best move at the time.
The present farm with 160 acres of land for hay and grazing now supports 50 cows. Fred adds 10 to 20 cows each season to increase the herd. That has allowed him to cut back the hours he works for his neighbours and to build up $75,000 equity, which he uses as working capital for the feeding business.
Fred went to see Don Forbes and Erik Forbes of Don Forbes Associates/Armstrong & Quaile Inc. in Carberry, Manitoba to determine when he might be able to retire with an assurance of being able to have $2,000 a month after tax.
Getting to retirement
Fred’s largest asset at present is his $210,000 of mutual funds divvied up into technology and growth stocks and resource plays. He pays more than average 2.6 per cent management fees for these funds which, because of their narrow focus on individual and currently declining sectors are more volatile than broad market funds. His portfolio has produced a long term average return of 8.5 per cent for the last 10 years, but it’s been a roller coaster ride. First move, Don Forbes suggests, is to move money into broader funds with lower fees.
Many low cost managed funds with fees of no more than one per cent a year are available, Don notes. The selection includes large cap, dividend paying familiar names and investment grade bond funds. Investment grade bonds issued by the Government of Canada and provincial governments tend to rise in price when stocks fall, thus providing stability to the portfolio. The goal is to create a portfolio with acceptable risk. “While higher risk funds may produce the best overall rates of return, they can be less beneficial for income and, when markets drop, frightened investors tend to sell, reducing their future returns,” Don Forbes explains. Diversification among asset classes tends to stabilize portfolios and to allow investors to ride out falling markets with a degree of peace of mind.
Fred could retire at 61. If his RRSP were converted to a RRIF, it would produce an average of $12,000 a year for the next three decades, Erik Forbes estimates, with actual payments climbing from 3.45 per cent of portfolio value at Fred’s age 61 to 20 per cent of portfolio value at age 94. Fred’s other source of income will be Canada Pension Plan benefits which will be $520 per month if he takes it at 61. However, he can afford to wait to age 65. If he does that, he would have payments of 64 per cent of the present maximum of $1,065 a month or about $720 a month. He can afford to wait and should do so, Don Forbes recommends. Postponing application will work if Fred’s farm operation can make up the difference, that is, pay about as much as CPP at age 61.
Fred has $75,000 of equity tied up in his cattle feeding business. He could liquidate and then put the total limit as of 2015, $36,500, into a Tax-Free Savings Account. He has no TFSA at present. The remaining $33,500 could be invested in a taxable investment account or used to replace his old half-ton pickup.
There is a final question of Fred’s legacy. He has neither children nor spouse. His remaining 160 acres of farmland should be sold. It would bring about $288,000. He should qualify for the farmland capital gains credit, meaning that he would keep all the money from the sale.
Timing is everything
If Fred retires this year at age 61, his income will be $1,000 a month from his RRIF, $520 a month from CPP, $300 in farm income if his land is not sold for total income of $1,820 a month. He would pay 12 per cent average income tax and have $1,600 a month to spend. That’s 20 per cent below his $2,000 monthly after tax retirement income target.
If Fred delays retirement to 65, he would have $1,500 a month RRIF income depending on growth of its investments $720 a month from CPP, $564 from Old Age Security and $500 a month projected income from renting his 160 acres. That’s a total of $3,284 a month or $39,408 a year. After 18 per cent average Manitoba and federal income tax, he would have $2,700 a month to spend, well above his $2,000 after tax monthly target.
It would be possible for Fred to boost his income by doing part time work in retirement and thus reducing his draw on financial assets. The advantage to continuing working is that he will need to draw less and thus may be able to extend the payout period of his assets. If he also is able to increase the cash flow from his investments by shifting from risky growth stocks held in high fee mutual funds to low risk, dividend rich investments his liquidity can grow. A financial adviser could help make this transition from high cost to low cost funds. With time on his hands, Fred could also take a do-it-yourself approach and study capital markets, stocks, economics and so on so that he will be more the master of his financial fate and less a victim of it, Don Forbes suggests.
Considerations for singles
The Income Tax Act could be said to be unfair to single persons. Fred cannot share costs or split eligible pension income such as Registered Retirement Income Fund payouts with a spouse or anyone else in an equivalent to married situation. He cannot use the typically younger age of a spouse to reduce and extend RRIF benefits.
Given his lack of beneficiary, Fred should think of distant family members, charities or other good causes to endow at the end of his life. Certain property can be pre-donated as well in exchange for tax-deductible donation receipts from qualified charities. A will is an essential instrument for achieving these goals. Along with a will, Fred should have a health directive drafted to instruct a trusted person on how funeral and estate matters should be handled.
“This case shows that you don’t have to be wealthy to have a secure retirement,” Don Forbes says. “If you keep your retirement needs to $2,700 a month after tax, your present assets, with modest growth, will support you to age 95.”