A couple we’ll call Michael, 50, and Teresa 45, are heirs to a third generation family farm in Manitoba left to them by Michael’s recently deceased parents. Michael and his wife are both middle level managers, each in separate companies in Alberta, their home province. They are raising two children, ages three and six, and earning a combined annual gross income of $122,000.
Though he grew up on the 480-acre farm, Michael has no great passion for it. Yet he feels obligated to consider the idea of returning to the farm, for the farm is his legacy.
Michael’s alternative is to sell. A neighbouring farmer has offered him $588,000 for the entire operation (which includes some debt).
Michael and Teresa asked Don Forbes, head of Don Forbes and Associates/Armstrong & Quaile Associates Inc. in Carberry, Manitoba, to work with them to review their options. Should they leave their existing jobs and move to the farm or sell it, take the money and create a better life for themselves?
The issue is whether the farm can support Michael and his family. A review of Michael’s parents’ tax returns for the last five years shows an annual taxable income in the range of $20,000 to $30,000 per year. If that’s the total income that can be earned from the farm, quitting their jobs would entail a decline in their way of life, at least in financial terms, for Michael and his family.
Moreover, Michael and Theresa would need to sell their present home and use the $300,000 of equity to recapitalize the farm. The farm machinery needs to be updated, and the farm is in need of more operating capital. They would also have to improve the farm house and use their capital to subsidize their living costs.
Ultimately, they would need more land to make the farm economically viable, says Forbes. And even if a few hundred acres of land were available at the current going rate of $1,200 to $1,300 per acre, the interest costs they would incur on borrowed funds would exceed the budgeted economic return. It is doubtful that this farm can be turned into a grain operation able to sustain the family.
Reducing the scale of the operation by turning the operation into a market garden farm is not possible in their area — they are located far from urban markets. Likewise, attempting to create a high cost dairy farm would not be possible. Even a beef cow operation would be doubtful, for the lack of scale would work against them, Forbes says.
It comes down to whether to eke out a marginal existence on the farm, or to sell the farm and use the cash to make life better for themselves and their children. Their present budget is tight, even with their six figure incomes.
Last year, out of their $122,000 annual gross income, Michael and Theresa paid what may regarded as non-negotiable or fixed costs of $32,000 for income tax, $6,000 for Canada Pension Plan (CPP) and Employment Insurance (EI), $10,250 for daycare for their children and $12,480 for mortgage payments. That left $61,270 for other costs of living — about $5,100 per month for food, gas and repairs for two cars, entertainment, travel, myriad expenses for their small children, clothing and grooming and all other expenditures.
They were not able to save much for their Registered Retirement Income Funds (RRIFs) or their Tax-Free Savings Accounts (TFSAs).
Selling the farm
Michael and Theresa expect to be able to realize $588,000 from sale of the farm. With that money, they could pay off their $132,000 mortgage and contribute enough to their large Registered Retirement Savings Plans (RRSP) space to bring their tax rates down to a middle range. The farm sale will enable them to put $40,000 into their RRSPs this year and another $18,000 into their RRSPs next year. Teresa plans to quit her job. If that happens, Michael can use a spousal RRSP to take advantage of what is likely to be a low tax rate when Theresa withdraws funds.
They can also put $2,500 for each child into the family Registered Education Savings Plan (RESP). The Canada Education Savings Grant (CESG) of the lesser of 20 per cent of contributions or $500 per child will push total contributions with growth at 4.5 per cent per year to an approximate value of $118,000 in a dozen years. By the time their eldest child, now six, is ready for university or other post-secondary training, the account will have about $118,000. Reduced contributions of $2,500 per year plus the $500 CESG can continue another three years until the younger child is ready for university. The account can be split so that each child has about $60,000 for four years of tuition and some expenses.
Michael and Teresa can also use their inherited cash for TFSA contributions. They can use all of their available TFSA space, $15,000 each, and then put $5,000 per year into each account in future years.
The balance of money realized from the farm sale, can go into a joint, taxable investment account. They should overweight dividend-paying common stocks to obtain partial tax relief via the dividend tax credit, Forbes recommends.
With the new income and asset structure, the family will have $66,000 from Michael’s annual gross income. He will have larger personal and dependent deductions that will lower his taxes to $3,000 per year, $3,000 of CPP and EI contributions, and, as a result, about $60,000 of discretionary income, not far from what they had with both parents working and a mortgage to pay. Deducting other costs of living from the net family after-tax income, they will have a surplus of about $2,300 with no debts to pay.
Michael and Teresa can aim for retirement when he is 60 in ten years time. They can reduce the deferred tax on assets in their RRSPs by taking $1,000 per month from each of their RRSPs along with another $1,000 each from their taxable investment accounts. With those capital reductions, the tax payable in a decade would be no more than $1,000 per year for Michael and zero for Teresa, who will not be working, Forbes says. Both would apply for early CPP pensions. That would add another $700 in future dollars in 10 years time, rising after she applies at her age 60 to $1,200 per month in 15 years, Mr. Forbes estimates.
When Michael reaches age 65, increased personal tax credits will eliminate any residual tax payable. He can then access what will be about $64,200 in his TFSA account, based on $5,000 per year annual contributions for each person and asset growth at 4.5 per cent per year. At 65, Teresa can access her TFSA balance, which will have risen to $163,900. Withdrawals from the TFSAs will not be taxable, Forbes says.
By the time Michael is 70, he and Teresa will be receiving a total of $30,850 in CPP and Old Age Security in future dollars. They will be able to add $13,570 in investment income and withdrawals, including TFSA cash flows, and $24,000 in Registered Retirement Income Fund (RRIF) income for total income of $68,420. Their lifestyle expenses will be slightly higher, though they can easily cover the expected deficit of $1,700 out of capital, Forbes says.
The value of their estate will have risen to about $1.5 million. It is a sufficient amount to sustain the couple for life and to leave a legacy for their children.
“This plan is an efficient way for the couple to cope with a farm situation that is financially unworkable and to give themselves and their children more secure lives. It is a solution that makes a bad situation good.”
Not every farm can be saved, Forbes says. “When the money is not there, when the will is wavering, when scale and basic economics work against continuation of a family farm, then it is time to face up to the reality that making it work would involve toil and risk of loss in excess of expected gains. In this case, the future of the kids would also be at stake. So the economics and the human side suggest that Michael and Teresa take the solution this analysis justifies.” †