Retiring Asset Rich But Cash Poor

Not far from Selkirk, Man., a couple we’ll call Charles, who is 80, and Maude, who is 74, farm 525 acres. They’ve been there for 60 years, raising their own beef and living a good if not wealthy life. Nearby, their son, who we’ll call Ted, 55, farms 1,000 acres. Their daughter, 48, who we’ll call Esther, is self-employed off the farm in retail sales. She has no interest in farming.

Ten years ago, Charles and Maude bought a house in town for retirement. It is rented out until they are ready to make their move. But the couple isn’t ready to quit yet, for they need the income the farm produces. For now, their monthly income consists of two Old Age Security benefits of $517 each, Charles’ Canada Pension Plan benefit of $484, Maude’s Registered Retirement Income Fund payment from a spousal plan of $309, for a total $1,827, plus $1,300 per month in variable farm income.

The total, $3,127, is their modest reward for a life of hard work.

Life in town will cost them $2,500 to $3,000 per month, they estimate. If they have no farming income, their public pensions — OAS and CPP — would only provide $1,827 per month. They could be in a significant deficit position. Any transfer of the farm to their son and to Esther will have to preserve their farm income or an equivalent. At the same time, they must create a path for transfer of the land and farm equipment.

Farm Financial Planner asked Don Forbes, who is head of Don Forbes &Associates/Armstrong &Quaile at Carberry, Man., to work with Charles and Maude. He notes that the farm will be Qualified Farm Property and will therefore be transferrable to the son with no capital gains tax. The homestead, which is the farm house and related land, is a principal residence and will be transferrable at any price with no capital gains tax.

There is a hitch when it comes to occupying the town house. When it becomes the couple’s principal residence, it should be appraised so that any increase in value above what they paid for it can be accounted for and taxed as a capital gain, Forbes cautions.

Grain inventory and any other farm income for 2010 will be taxable as long as farm revenue exceeds farm expenses. Farm net income will add to their cash flow until the operation is transferred to the children.

THE CURRENT PLAN

The present estate plan is to transfer 240 acres out of their 525 acres to the son plus the yard site with its 65 acres of land. The transfer would include all remaining farm machinery and half of the

net value of any off-farm investments.

Their daughter would receive 220 acres and the house in town plus 50 per cent of off-farm investments within Maude’s RRSP. Charles has no RRSP of his own, having used an income averaging strategy to provide income to Maude in retirement while reporting all farming income in his own hands. The transfer to the daughter would require sale of RRSP assets and would be taxable, Forbes warns. The house in town and the farm yard site have been valued at $150,000 each, Forbes notes. The RRSP currently has a value of $125,000.

There are other ways to handle the legacy for the children. Each involves a shuffle of assets to satisfy the interests of the parents and the children.

1) Continue farming and receive farm income. Esther would receive 220 acres with the residue of the estate going to the son after the death of the last parent. Who will farm the land after the death of the first parent or even before either passes away needs to be clarified in the present will as amended or in a new will, Forbes says.

2) It would be possible to add Esther to the title jointly held by the parents so that she automatically inherits at death without any probate process. The disadvantage of this is that any problems Esther may have prior to the death of the last parent will accrue to the farm. Were Esther to go bankrupt, creditors could seize the farm or demand that the parents buy back her one-third interest. The buyback would have to be in cash. This plan has the virtue of simplicity and immediacy, but a high and perhaps unacceptable contingent risk, Forbes says.

3) The parents could sell the 220 acres to their son with the parents taking back the mortgage on it. The principal part of the mortgage payments could be set aside in a Tax- Free Savings Account as a legacy for Esther. The parents would continue to receive the interest as their own income. The unpaid principal would be assigned to Esther at the death of the last parent. This is a complex procedure, but it guarantees that Ted should be able to continue to farm the land for the indefinite future, Forbes says. The rate of interest on the mortgage would need to be fixed for an extended period in order to protect both the parents and Ted.

The basis for the various plans is to lock up farm income or an equivalent from interest on a take-back mortgage. Assuming that they continue to receive farm income or interest on the take-back mortgage, their monthly income would consist of $1,827 in combined CPP and OAS benefits and Maude’s RRIF payments, $1,300 from farming operations per month for a total of $3,127 per month or $37,524 per year before tax.

Charles and Maude are approaching the end of what amounts to a pleasant life of subsistence farming and limited market farming. They know that they cannot continue to farm for many more years and so must accept the need to transfer interests to their two children.

AndrewAllentuck’sbook,WhenCanIRetire? PlanningYourFinancialLifeAfterWork,was publishedin2009byVikingCanada.

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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