Farm Financial Planner: Transition: two children, one farm

A farmer we’ll call Sam, 62, and his wife Ursula, 59, farm 10 quarters of grain in central Saskatchewan. Helped by their son, Ernie, and his wife, Maria, both 35, they have developed a very successful operation. The farm generates an average of $175,000 a year and the couple operates equipment for roadwork, snow plowing and other tasks for another $125,000 a year. The combined businesses gross $300,000 a year after expenses. The problem? Transferring the business to Ernie and transferring money to a daughter who works off-farm.

The farm as now organized is both an agricultural enterprise and, through the heavy equipment business, an industrial undertaking. It has substantial value with farmland estimated to have a value of $1 million, farm equipment valuing $750,000 and their heavy equipment with a value of $1.2 million. They have cash in the bank of $200,000. They have a choice of extending the farming business or letting Ernie buy them out so that they can retire. Furthermore, they have kept their income down by taking available capital cost allowance on the equipment and deducting interest paid for past land purchases.

With the success of their two lines of business, they have eliminated all debt. The farm and its heavy equipment operation are relatively simple jewels that spin out money. They want to make preparations to leave some of their wealth to their daughter — we’ll call her Rose — who is a health care professional in another province. Rose has a family with two young children. Their choices are essentially whether to take money out of their businesses for family financial planning or to leave the money in the businesses for future growth.

Sam and Ursula contacted financial planner Rod Tyler, head of the Tyler Group in Regina, to review and evaluate their choices. Tyler says that squeezing cash out of the businesses above usual salaries would reduce its financial strength. There are other ways to look after Ernie and Rose.

Evaluating the choices

The choices which need to be evaluated are whether to keep money in the business for growth or to take it out for family uses and retirement. And those choices in turn need to be evaluated in terms of tax consequences.

Retirement is not far away for Sam and Ursula, so they need to make decisions and preparations. At present, they have unused RRSP room of $195,000 for Sam and $85,000 for Ursula. Neither has a Tax-Free Savings Account. Sam and Ursula think they could live on $6,000 a month after tax when retired. Their home is paid for and their only expenses would be utilities and the customary expenses of living. That means getting from present to retirement in the future.

If Sam and Ursula want to sell the operation to Ernie, they can each use half the capital gains exemption which was moved up from $813,600 to $1 million for qualified farming and fishing property for dispositions after April, 2015. The enhanced deduction is for individuals and applies to tax years after 2015. The $1 million they can get for the farm will not be taxed.

A legacy for their daughter, Rose, and her two children, nine-year-old twins, can be achieved via Registered Education Savings Plans and life insurance. Neither child has an RESP. If Sam and Ursula take over the job of funding the children’s educations, they could contribute $2,500 per child per year and capture the Canada Education Savings Grant of the lesser of $500 or 20 per cent of contributions in each calendar year. They can also do catch ups with certain restrictions, among them, a lifetime limit of $50,000 per beneficiary and $7,200 CESG per child.

In addition, Sam and Ursula could buy life insurance with Rose and Ernie as beneficiaries. It would be a bequest and make it possible to give them money without having to sell any of the farm. If they go this route, Sam would pay $990 a year for $200,000 of term coverage for 10 years and Ursula $510 a year for the same coverage. If they go to 20-year terms, the costs would be $2,078 a year for Sam and $1,008 a year for Ursula. Benefits could be adjusted so that Rose would have a large share to compensate for eventual transfer of the farm to Ernie. As Ernie works to pay off the buyout loans, his share could decline in favour of Rose — or as the parents prefer. Changing beneficiaries would be easy, though the parents should take accounting advice in each change.

If Sam and Ursula contribute $5,000 per year for each of the next eight years and achieve three per cent growth after inflation, the RESP would have $100,750. Evenly divided, each child would have $50,375 for post-secondary educational expenses. That would pay for tuition at any university or college in Saskatchewan. The kids could supplement their incomes with summer jobs.

The farm transfer

Transferring the farm to their son Ernie could be done with a series of planned sales. He could borrow funds needed to pay his parents at the low interest rates currently prevailing. Rates are likely to rise in the coming decade, but secured loan costs should remain below historical trends. The workout of value and transfer to Ernie could be set for 10 years. If Sam and Ursula sell $100,000 of land for 10 years, he would own the farm. Sam and Ursula would have $1 million in their savings or investment accounts. They could allocate money to their RRSPs in years in which their marginal rate is 40 per cent or more, which, in Saskatchewan, means individual pre-tax income of $45,000 or more.

The money could go to filling their RRSP space and, when that is completed, they could use TFSAs to a 2015 maximum of $46,500. If they build up RRSPs with $10,000 each for the next three years and obtain a three per cent return after inflation, the RRSPs, which have a current value of $155,000, would be worth $233,000.

The TFSAs, filled to $46,500 each with cash from their $200,000 bank balance and enhanced at a rate of $5,500 per person per year for three years, would have a balance of $35,000. We’ll let remaining cash balances of $107,000 be used for farm working capital. The combined RRSP and TFSA accounts

Adding up TFSA and RRSP balances in three years’ time, the couple would have $268,000. That sum, if paid out as annuity so that all capital and income is distributed in the 30 years from Sam’s age 65 to Ursula’s age 95 would produce $12,600 a year. They could add $100,000 a year from the land sale to Ernie for 10 years, CPP of an estimated $12,000 a year for each of them, and two Old Age Security benefits at the 2016 rate of $6,846 a year for total income of $150,300. After estimated 25 per cent average income tax, the couple would have $9,400 a month to spend. They could save $10,000 a year to build a fund for the time that the $100,000 buyout from Ernie ends.

Farm equipment could be willed to Ernie. Its cost base would depreciate over time so that the deemed disposition which occurs at death would not be a large cost to the estate. Any taxes due on transfer of the farm or equipment over the lifetime capital gains exemption could be covered by term life insurance, Tyler notes.