Alberta farmers we ll call Hank, 63, and Ethel, 62, have raised elk and bison and grown grain for three decades in the foothills of the Rockies. Hank has also been an employee of the federal government. He retired with a full pension three years ago at age 60. They have one son with a different career path who is not interested in taking on the family farm.
They were fortunate to get into elk and bison relatively early in the boom for exotics. The business was profitable for many years, but the BSE outbreak in 2003 injured their business and cut is profitability. Today, they still have to do chores, but their business is poor. They wind up subsidizing it with $10,000 per year of their savings. It s time to move on, they say.
They want to downsize their operation, which is now just a few bison, and get more time to travel. It is a process already underway, for they sold 220 acres for $200,000 three years ago. They used the cash to pay off all bills and are now free of debt.
What s next is the issue, for while the bison business is losing money, the land has appreciated dramatically. Hank and Ethel want more time and more economic security in retirement.
We asked Don Forbes, a farm financial planner who heads Don Forbes &Associates/Armstrong &Quaile Associates of Carberry, Man., to work with Hank and Ethel. His plan downsize the farm, make use of tax breaks available to farmers, and invest for dependable income.
First move: sell remaining 300 acres of land remaining in his 450 acre parcel for $400,000. Then transfer remaining land to the son as a legacy. The declared value of the transfer will be one dollar. The value of this transfer is that he will receive the legacy at the tax paid current value.
Next move: The farm meets the standards for the Qualified Farm Property Capital Gains Exemption. Assuming that the combined sale price of $650,000, which is sale price plus the deemed value of what is transferred to the son, minus book value of $210,000 results in a $440,000 capital gain, there will be an offsetting tax credit. The proceeds will be received tax-free.
The timing of the sale and transfer are critical. They should be done over the next two years before each partner is 65. That way, Old Age Security will not be clawed back on the basis of the capital gain. Even though there is no tax on the gain, it does boost notional income, Mr. Forbes explains. Moreover, the transactions should be split in order to reduce the impact of the Alternative Minimum Tax that effectively brings excluded transaction back into taxable income.
Along with the sale of land, Hank and Ethel should sell their farm machinery and livestock. Assuming that the current market value of this property is $65,000, there may be a taxable recapture of depreciation, Mr. Forbes cautions.
Ethel worries that capital markets are unsteady. It is possible to structure investments of the $465,000 cash proceeds (the balance is the son s legacy) of the farm and equipment sale to produce predictable income.
First, take $200,000 as Ethel s share of the cash realized that s half the total and buy a life annuity from an insurance company. That capital would provide $12,672 per year for her life with a guarantee that a minimum of ten years worth of payments would be paid. That s a yield of 6.34 per cent on what amounts to a long bond. Government of Canada 30 year bonds pay only about two thirds of that. The extra return is based on the insurance company s ability to invest in corporate bonds and to keep undistributed money
after Ethel s passing. There is also a non-taxable return of capital component of $9,000 per year in the payout.
The annuity payments will qualify for the $2,000 pension income credit A word of caution: interest rates remain below their historical averages. The foundation of annuity payouts remains interest on long government bonds. Assuming that rates rise in the next 18 to 24 months, the annuity purchase should be delayed until perhaps 2013 when Susan is 64, Forbes suggests. However, the annuity is more than just a device to produce steady income. In a sense, it is a life insurance policy that produces income in life rather than in death. It is also substantially guaranteed by Assuris, the life insurance industry s guarantee fund, that protects 85 per cent of promised benefits and up to $100,000 of principal. For a full, 100 per cent guarantee of $200,000 of principal, the annuities could be purchased from two insurance companies.
Second, invest the balance of $265,000 in non-registered, jointly owned assets with a blend of large cap, dividend paying stocks and low fee exchange traded funds.
The stock investments should make it possible for the total portfolio to rise in value with inflation, compensating for the declining real income that will be produced
by fixed payout annuities. This investment portfolio does will rise and fall with capital markets. To reduce fluctuations, it would be possible to sell the more volatile components, such the the BRIC and agriculture ETFs and to use to proceeds to buy a laddered bond fund. It s a tradeoff of growth for reduced volatility.
Once the farm is sold, $10,000 per year that the couple has used to subsidize its losses can be switched to a travel fund. Other parts of cash flow can be used to boost
Tax-Free savings accounts. TFSA growth and payouts are not subject to tax and therefore have no impact on future Old Age Security payments. Moreover, with some planning, the couple can plan to split Hank s government pension income and all retirement income when both are 65 in 2013
These steps seem complex, but they are really just a way of converting farmland to stock, bond and annuity investments. If these steps are taken, then by 2013, when Hank is 66 and Ethel is 65, the couple will have two Old Age Security benefits of $6,481 each per tear, total Canada Pension Plan benefits of $9,137, employment pensions totaling $41,136, taxable dividends of $2,973, interest of $3,118, taxable gains projected at $8,358, Ethel s annuity payment of $12,672 per year and RRIF payments of $10,354 for total income of $100,710 before tax. Assuming that they pay a 15 per cent average tax on all income, they will have $85,600 per year to spend on a new way of life.
They have already bought house in town and paid for it in full, so their income, apart from utilities and house maintenance of perhaps $15,000 per year, will be theirs to spend on travel and much of the good life they postponed while building up their farming business. They can set aside a fund of $6,000 per year so that they can buy a new car every five years. As their lives progress, they will have the option of cashing in some stocks or bonds to raise income, should they wish to do so.
The conversion of farm to capital market assets will not only make it easier to convert assets to cash, but to adjust the portfolio to the changing levels of inflation, to invest in Canada or other countries with perhaps what will be stronger economies or stronger currencies. This is not a prediction, but only an acknowledgment that the only certain thing about the future is that things will change. Most of all, they are going from duty to the land to living for themselves. And that, of course, is the goal and idea of retirement.
AndrewAllentuck slatestbook,WhenCan IRetire?PlanningYourFinancialLifeAfter Work,waspublishedbyPenguinCanadain January,2011.
Land sales should be timed so as not to impact other sources of retirement income