A couple we’ll call Molly and Frank, who are 30 and 33 years old, respectively, farm 1,400 acres of grain and pasture in Manitoba’s Interlake district. They have a new child, Emma, and are looking ahead to the time they will retire. That could be three decades in the future, but, though distant, the exercise is at least instructive and could even help with current farm management.
Molly and Frank are unusual in that they recognize not only future financial issues but distant goals as present challenges. They are farsighted in seeking a long-range plan.
Molly and Frank consulted Colin Sabourin, a certified financial planner and partner in Winnipeg-based Harbourfront Wealth Management. Their goal — a way of building net asset value for the family and the farm, and planning for a way out when they retire.
The couple’s present income is based on $37,000 from Molly’s work as a part-time administrator in a medical clinic and $30,000 annual income Frank gets from the farm corporation.
Their immediate challenge is to build up cash for a down payment on a new house. Their target — $300,000 in five years for the move-up house. They also want to save for Emma’s education. To do that, they expect to maximize the Canada Education Savings Grant (CESG) of the lesser of $500 or 20 per cent of contributions to a Registered Education Savings Plan. Their final goal is to build up capital for retirement at 65.
The couple is spending every dollar they make on current expenses, so they will have to use the farming corporation’s retained earnings, including cash in the bank, to accomplish their goals, Sabourin explains.
The farming corporation has over $400,000 of cash and inventory on hand, the planner notes. There is a $60,000 shareholder loan on the books. The farm itself is profitable with pre-tax income of $235,000 in 2018 and $205,000 in 2019.
The couple’s individual assets are $63,000 combined in Tax-Free Savings Accounts (TFSA), $33,000 in Frank’s Registered Retirement Savings Plan, and their $200,000 house.
The financial resources for their plans are in place. The first move, strategically, is to move wealth from the farm to their personal accounts, Sabourin advises.
The couple has $73,000 of contribution room this year in their TFSAs. They can move $60,000 from the farm corporation with no tax on the withdrawals. The money for this move will come from the shareholder loan and thus the withdrawal will have no tax consequence.
They can withdraw $60,000 from the farm corporation and put it into Molly’s TFSA. She already has $40,000 in the account, which will then have a $100,000 balance. Combined with the house that has a $200,000 value, they will have about $331,000 assuming that both cash and the house appreciate at two per cent per year. After a five per cent selling cost for the house, they will have about $320,000 left for the purchase. Withdrawals from Molly’s TFSA will be tax-free as will proceeds of the sale of their existing house.
If Molly and Frank then sell their existing house for its estimated price of $200,000 plus two per cent appreciation, or $208,000, less five per cent primping and selling costs, they will have $197,600 plus $138,375 from the appreciated TFSA. Their cash on hand will be $334,975. The surplus can be used for furniture and fittings and other goals.
This year, Emma will be two years old. Born in 2019, she will have RESP room of two years times $2,500 plus two years of CESG grants — there is a carryback provision that allows this — $6,000 total. Each year, Molly and Frank can make $2,500 contributions, receive the $500 CESG until they reach the lifetime limit of $7,200 per beneficiary.
The maximum per beneficiary allowed by the RESP rules is $50,000, but without the CESG, RESPs are less attractive, Sabourin notes. The advantage is a lower tax rate when funds are withdrawn by a beneficiary, Emma in this case, but if she has good summer jobs or the parents have poor years, the income tax rate differential disappears. In any case, the parents can quit in 13 years. By then, assuming that the RESP account generates three per cent per year after inflation, Emma will have about $55,000 for her post-secondary education. That should pay the bills for any university in Manitoba including some living costs. Summer jobs would cover any deficit, the planner notes.
Retirement remains the major goal and problem. The couple has no Tax-Free Savings Accounts now. A TFSA is not only a 100 per cent shelter, it also allows for temporary and replaceable withdrawals for personal use or even farm use should the need arise, Sabourin notes. Moreover, any money transferred from a personal TFSA to the farming corporation would be a shareholder loan that could be withdrawn with no tax penalty.
Additional funds taken from the farm can go to Frank’s RRSP on the theory that his income from the farm increased by $12,000 per year, he will be able to keep about $8,500 per year based on a tax rate of 28 per cent in his income bracket. Money going into Emma’s RESP will be post-tax (but compensated by the 20 per cent CESG, leaving a final tax cost of eight per cent).
The plan works because the $60,000 withdrawal via the shareholder loan take-back plus a salary increase of $12,000 from the farming corporation will produce sufficient income for living costs, finance a new house, generate money for Emma’s post-secondary education, and set a base for both transfer of a profitable farm to Emma should she want it in perhaps three decades and, finally, set a base for growth of the farm’s value.
If the farm remains intact, its 1,400 acres prices at $2,000 per acre at today’s values would rise from $2.8 million to $5 million assuming a two per cent average annual increase in price compounded once a year.
We do not know what Emma’s personal finances or relationships will be in 30 years. However, if the farm has been profitable, there would be a base for transfer at a cost set between original price, leaving a large future capital gain, or market value, which under present tax law would give the parents a large one-time gain and a high cost including probable loss of Old Age Security benefits, currently $7,362 per year, to the OAS clawback that currently starts at about $79,000 per year.
Excess tax paid via application of the Alternative Minimum Tax would be recoverable in future years when OAS was presumably restored — depending on how productive farm capital paid out to the retiring parents will have been.
“By withdrawing $60,000 from the farm today via their shareholder loan and increasing how much they are withdrawing annually from their farm corporation, they are able to accomplish their personal goals while remaining in a low tax bracket and keeping enough cash in the farm for future use,” Sabourin concludes. Thus, the plan accomplishes the goal of buying a new house for Molly and Frank, setting up a fund for Emma’s post-secondary education, and financing a retirement.