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Retirement income and inheritances

How to create a retirement plan and leave a legacy for your children

In central Manitoba, a couple we’ll call Jack, 57, and Susie, 54, have found themselves in a crisis. The couple left active farming and now rent their land to a neighbour. Sixteen years ago, Jack got a city job and sold 480 acres of the farm, half its original 960 acres, to pay debts and to provide cash to buy a house in town. Their concerns now are retirement income and inheritances for their four adult children.

The land retained and the farm house they now rent out generate a $20,000 annual pre-tax return. Jack and Susie want to create a retirement plan based on retaining 480 acres as a legacy for their children.

Farm Financial Planner asked Don and Erik Forbes of Forbes Wealth Management Inc., located in Carberry, Man., to work with Jack and Susie. Their own retirement finances are predictable. Jack now works for a municipal government. In the usual course of things, an employee with 40 to 45 years of service could expect that his or her total package of pension, Canada Pension Plan (CPP) and Old Age Security (OAS) income would be about 70 per cent of regular salary at age 65. For now, Jack can expect a $953 per month employment pension at age 65.

In Jack and Susie’s case, with a late start entry to the municipal defined benefit pension plan, Jack will have to catch up. Jack can do that by matching the town’s contribution to his plan, $12,000 per year, allocating 25 per cent of net farm rental income to his Registered Retirement Savings Plan (RRSP) and the same amount to Susie’s RRSP. That works out to $5,000 each per year. It is consistent with how they save now.

Jack and Susie are saving a quarter of his yearly income of $57,000 salary and $10,000 farm rent. Susie saves about $5,000 per year of her annual $34,000 salary.

Tax management has to be part of the couple’s retirement plan. Better now than later, Don Forbes explains.

“It is better to pay modest amounts of income tax each year in a range of 26 per cent to 33 per cent of taxable income rather than to defer the maximum amount of tax until death, where the estate might have to pay tax at a rate of 50 per cent or more.”

The couple’s largest capital asset will be their personally owned farmland. Gains will be offset by the $1 million personally owned farmland capital gains exemption each for Jack and Susie — that’s $2 million in total. In addition, gains in the value of their farm house and one acre — total estimated value $550,000 — are exempted. The total of $2.55 million will be tax-exempt.

Leaving a legacy

Next planning consideration: the value of farm to be transferred to children can be anything between historic book value and today’s market value. If book value, capital gains accruing to parents may be low but potential future gain to children may be high. In the opposite case, if transferred at today’s prices, capital gains over the exempted sums may be high but value base for children when they take any future gains from sale will be less than in the former case.

The plan should use up eligible tax credits and tax exemptions without claiming the entire market value of the farm and having to pay tax as of the day of transfer. Next is the question of which children get what. There will be a value in the $960,000 entirely offset by the farmland capital gains exemption. The land itself can have a value of $2,000 per acre, which they can retain in full by qualifying for the farmland capital gains credit.

However, in the year of realization of gains, before the offset, all of their individual OAS benefits that start at 65 for each would be clawed back and the alternative minimum tax (AMT) imposed. The AMT itself would be recoverable in years after it is paid as a credit on future income due in the following seven years. It is important that this be done in years before a final return is filed, Erik Forbes notes.

The transfer of land and related assets could be done in the near future to eldest son, Peter, who lives next door to Jack and Susie’s farm. The remaining three-quarters can be transferred to the other three children. That provides a rough equality of assets transferred. Any shortfall could be made up by money from investment accounts, Don Forbes explains. They have not established Tax-Free Savings Accounts (TFSAs).

To protect the family’s assets to be transferred, it would be wise for Jack and Susie to take a zero per cent interest promissory note on the land. That protects the parents’ future retirement income in the event that any child were to get into financial difficulties through divorce or bankruptcy.

Were that to happen, creditors or an estranged spouse could seek the value of assets, but would have to pay the parents first before claims could be considered. “This way you give title of the land to the children but you maintain control of it if you are relying on it for a part of retirement income,” Erik Forbes adds.

When both Jack and Susie are 65, they will have two OAS pensions at $7,362 per year each. That works out to $1,227 per month combined. Their CPP benefits will have a combined value of $1,846 per month. Jack and Susie’s work pensions will total $1,085 per month. And RRSP/RRIF (Registered Retirement Income Fund) income will total $1,800 per month.

Jack and Susie can add land rent if they have not sold the remaining acreage. That would add $1,660 per month to income. Investment income would be $200 for non-registered assets. We are not including TFSA income. We will regard it as an emergency fund. The total of valued income streams would be $7,928. Assuming that they pay an average combined $1,200 per month for income tax, they would have $6,728 per month to spend plus any money taken from TFSA accounts. The $6,728 is more than their $5,000 target after-tax retirement income with inheritances planned and taxes averaged at relatively low rates for many years.

This plan allows for TFSAs to be established and to absorb income over the estimated amounts. If Jack and Susie add $4,000 per year combined to TFSAs starting when Jack is 65 and if the assets grow at a nominal rate of two per cent just to keep up with inflation, then when Jack is 70, the TFSAs would add up to $8,500, at the age of 75 to $29,000 and at his age of 80 to $49,000.

At the age of 90, the TFSAs would have grown with surplus income and our estimated modest two per cent annual return to $66,700. TFSA capital growth and income could not be taxed on a final return. TFSA cash flow would compensate for loss of splitting of eligible income at the death of the first partner and loss of his or her OAS and CPP and job pensions without survivor benefits.

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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