Lots of landowners plan to return to the farm later in life. Funding retirement and leaving a legacy will require some planning
Stephen, as we’ll call him, started an 800 acre mixed beef and grain farm in central Manitoba in the late 1970s. By 2002, Stephen had had enough. He sold his beef cow herd and 320 acres of farm land and headed to Alberta to work as a welder.
Stephen saved little of his wages over the years and will have only a modest union pension, Canada Pension Plan and Old Age Security. The farm is his principal asset.
After downsizing his farm, Stephen was left with 480 acres of land, debt-free. Today, it has an estimated value of $300,000. He has leased it to neighbours for $20,000 per year, a 6.6 per cent return on equity before tax.
Now that Stephen is 65, he wants to retire to the farm, taking his son, Sam, 45, and Sam’s wife Lottie, 42, into the farming operation. He also wants to establish a financial reserve to provide a legacy for his two younger children who won’t be farming.
Farm Financial Planner asked Don Forbes, head of Don Forbes & Associates/Armstrong & Quaile Ltd. to work with Stephen to formulate a method to transfer the farm to Sam and Lottie, produce retirement income and arrange a legacy.
The easy part is to build Stephen’s retirement income. Using current dollars, he can expect Old Age Security of $6,481 per year, Canada Pension Plan benefits of $9,240 per year and a $15,000 union defined benefit pension. This will give him a total pension income before tax of $30,721 per year.
After income tax ($2,800) Stephen will have $27,921. On top of that, he can add after-tax farm income of $13,546, bringing his total income to $41,377 per year. But there are other ways to construct his retirement income.
If Stephen could get by on just his pension income, there would be more farm income left for Sam and Lottie. He has several options to consider.
First, he could sell the farm at fair market value and claim the qualified farm property capital gain tax credit of as much as $750,000. Stephen can sell the land and take a tax-free gain, while Sam and Lottie borrow to finance the repurchase of the farm.
Or, Stephen can roll over the property to Sam and Lottie for a nominal cash value, but declare the transfer at market value. Stephen would still claim the qualified farm property capital gain tax credit on his increase in value over his adjusted cost base. But this would leave Stephen with no cash for his retirement and no legacy for his non-farming children.
Stephen can also use life insurance to create a fund for the non-farming children.
Option One: Draft a long-term rental agreement. Stephen could make his son and daughter-in-law tenants. That would allow them to farm, pay rent to Stephen (providing him with retirement income), and leave the transfer of ownership of the land as a legacy for Sam and the other children.
Option Two: Mortgage the farm. With a $200,000 mortgage, Stephen would have cash for his retirement. By investing conservatively in stocks and bonds, Stephen might be able to draw perhaps six per cent or $12,000 a year. Lenders would probably want to lend less than full value, so this choice would create complexity and risk and perhaps not produce sufficient income.
Option Three: Keep the farm as is with Sam and Lottie farming, and buy a $200,000 term life insurance policy with premiums level to Stephen’s age 100. The cost would be $6,000 per year. Alternatively, Stephen could buy a $200,000 whole life policy with growing cash value. The premium would be $13,300 per year for 15 years. After 20 years, the policy would have a death benefit of $348,000.
Forbes suggests combining the best of the alternatives.
The life insurance alternative leaves the farm in Stephen’s hands. The term life policy can be paid out of farm income on the core of the farmland. The fair rent for this land is $7,000 per year, so Sam and Lottie should be able to support the term policy’s $500 monthly premium. Aside from this, Stephen will still be left with $13,000 of other farmland rental income for his retirement. If Stephen were to choose the whole life policy either he or his children would have to subsidize the $1,108 monthly premium.
Once the life insurance policy is in place, Stephen can transfer the farm tax-free to Sam and Lottie without sale. If Stephen cannot get insurance at an acceptable price, he can just rent the farm to them. The rental charge can be fair market value, or less — if Stephen wants to subsidize their income.
As a final step, if the rental plan is adopted, Stephen should amend his will to ensure that Sam and Lottie get the land after his death.
Assuming that Stephen keeps the land and rents it to his son, Stephen’s retirement income would be $27,210 pension income plus $20,300 from farm rents, less $13,300 for life insurance — a net annual income of $34,210.
“This is a plan that will take care of Stephen in retirement and the kids for the rest of their lives,” Mr. Forbes say. By doing this, Stephen can “create stability and predictability for the farm and the family’s way of life.” †