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Farm Financial Planner: Finding a comfortable retirement

Farmers can turn marketing board quota and a modest income into a comfortable retirment

In southern Manitoba, a couple we’ll call Herb, 63, and Martha, 60, have a mixed farm with most of their effort and capital invested in producing poultry products for a group of grocery stores in Winnipeg. They operate 310 acres of land surrounding their 10-acre yard with an aging farm house, their 35-year old son’s mobile home, the chicken sheds and various outbuildings. Most of their capital is invested in the farm and its real estate with an estimated value of $2.4 million. Their problem: how to retire from the business.

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Their off-farm assets are just $100,000 of non-registered term deposits. To leave the farm, they would need to buy or rent a home in town. That would take, they estimate, $400,000. Their current combined income, $62,000 before tax, and their relatively small cash holdings make it imperative that they work out a way to sell the farm to their son.

Aware of the need to work out a way to quit and pass the farm on to their son, they approached Don and Erik Forbes of Don Forbes Associates in Carberry, Manitoba. Their prescription is a workout plan for the farm.

The plan

The farm has intrinsic value apart from the aging buildings. They have a production quota from their marketing board with an estimated value of $1.1 million. What is essential is to free up cash embedded in the land and buildings.

First move: approach the bank to reamortize farm loans for machinery from the current eight-year repayment period to 20 years. The present four per cent loan for $150,000 costs $1,800 a month to service. If they shift to 20 years, the cost at the same rate would decline by half and they would liberate about $908 a month.

Next: they have to work out a sale agreement with their son. The question, of course, is what he should pay. Assuming that the son has made an investment of his own via sweat equity that amounts to a third of the value of the operation, that interest, with an estimated value of $900,000 needs to be recognized, Erik Forbes suggests. That implies that their value in the farm and quota is $1.5 million. That is the amount to be financed in the buyout.

The plan has to be to convert the couple’s 200 common shares in the farming corporation into fixed value preferred shares. These 200 shares will be retracted by the corporation and the accumulated capital gain is switched to the preferred shares on a tax-deferred basis. The deferred gain would then be taxable as dividends on redemption or death. The son will continue to run the farm and benefit from any future increase in its value. In this plan, Herb and Martha’s interest in the farm will decline each year, giving the son a growing share of the business.

Tax implications

The workout plan has tax implications. The land qualifies for the Farmland Super Credit by the couple but the family farm corporation has different and stricter criteria to meet. The two key elements in qualification are: 1) the farm corporation has to have 90 per cent or more of farm assets in active production, as it will be, and 2) the purchaser of the assets has to be a qualified share purchaser, as the son will be.

The transactions required to value shares and to transfer them at agreed upon value to the son need to be vetted by an accountant or tax lawyer to ensure compliance. The Alternative Minimum Tax will remain a liability. The property transfer may then be done over several years to reduce the AMT cost. Some of the AMT that may be paid can be used as a credit against future tax, Don Forbes suggests.

To ensure that, in a financial sense, the succession plan works, the farming corporation should buy a key person lie insurance policy for the son. He is 37, does not smoke, and could probably be insured for $2 million at a cost of $106 per month for a 10-year level term. That would ensure that the corporation is protected in the unlikely event of the son’s death and would cover most of his debt. The policy would eliminate the need for costly mortgage life insurance and would have a tax advantage if the proceeds were received directly by the corporation, Erik Forbes adds.

Herb already receives Canada Pension Plan benefits of $421 a month. Martha can apply this year for benefits at age 60, which, with a 7.2 per cent per year reduction of each year before age 65 at which benefits begin, would be $370 per month. Each will receive Old Age Security benefits at $565 a month at age 65. A proposed shareholder loan for purchase of the farm by the son would pay the parents $3,500 a month. Redemption of preferred shares would add $2,180 to income on top of $100 of investment income from the couple’s existing financial assets and $400 for farmland rental to third parties. The total, $8,101 a month or $97,212 a year after 20 per cent average income tax, would leave the couple with $6,480 a month. After age 65, age credits for income, provincial seniors’ school tax paid and pension income deductions would reduce tax to about 14 per cent and leave their income for spending at $6,970.

This income and various buyout plans will provide the couple with $300,000 for purchase of a home in town. The son can move out of his mobile home into the farm house. There will be another $100,000 available for investment or for use as a down payment for the town home.

Beyond the farm transition workout is the problem of what the couple can do to enhance their way of life in retirement.

If they use the $100,000 cash payment from the workout for a home down payment, they will have no new investment problems. If they choose to rent, which is a viable choice if they can find a rental home which suits their needs, their income would support as much as $2,000 monthly rent.

If they therefore retain their workout capital and add it to their existing $100,000 of non-registered assets, they should discuss with their accountant a potential move of existing their assets, currently just term deposits, to a Tax-Free Savings Account. At present, they do not have a TFSA. The $82,000 available shelter would provide future tax relief. They might also seek investment advice to assist them in investing in stocks or exchange traded funds with yields higher than what their term deposits provide.

Many financial advisors like capital gains, which not only have lower taxes than income or, in most cases, dividends, but can be reaped at the asset owner’s will. If the couple’s financial assets do migrate to TFSAs, the tax issue will be irrelevant. But timing gains would be relevant. Thus it would be wise to choose stocks or exchange traded funds for stocks or bonds which have very low management fees, under one per cent in the case of mutual funds, under 0.50 per cent in the case of ETFs. The assets chosen should produce steady and rising dividends. These tend to be no decision assets in which dividends patch over times when capital markets slump.

“Herb and Martha can retire with more income, more income security, and less effort to earn a living than they have now,” Erik Forbes says. “All that is needed is to act with advice and prudence. They have earned a secure retirement.”

About the author

Columnist

Andrew Allentuck’s book, “Cherished Fortune: Build Your Portfolio Like Your Own Business,” written with co-author Benoit Poliquin, was recently published by Dundurn Press.

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