A couple we’ll call Jack (55) and Susie (60) have farmed in western Manitoba for most of their lives. They have 640 acres in their own names and farm 2,360 acres their parents owned or that they have rented.
When Jack’s father died 10 years ago, the farm was in jeopardy. Dad had not updated his will for 20 years. The document was basic. His wife would receive everything and the family assets would be divided among surviving siblings and their children when Mom passed away. There was no mention or credit given to Jack’s contributions through his work and dedication to the farm. Jack doesn’t want to create problems like this for his children.
Jack and Susie’s three children, all in their thirties, have careers off the farm. Since they don’t want to farm, Jack and Susie need to find another way to liberate the value of their business. Sale is the obvious route.
Today, Jack would like to sell his 640 acres of land, the part of the farm that he owns. He has an offer of $2,500 per acre. The farm corporation where Jack has an off-farm job has offered to match this deal, with payments spread over several years. Now the question is: which deal to take?
Don Forbes, a farm financial planner with Don Forbes & Associates/Armstrong & Quaile Associates Inc., worked with Jack and Susie to find the best deal and plan their transition to retirement.
Jack and Susie’s goals are 1) to retire in five years when Jack is 60 and Susie is 65; 2) to generate another $1,000 per month to add to their present $3,500 monthly spending for travel and other retirement expenses; 3) to sell four quarters of land over four years, starting in 2013 at $2,500 per acre or $400,000 for each quarter; and 4) buy a condo in town for $300,000 with that cash.
It’s all doable, but optimizing income from the various moves will take careful planning. Forbes’ plan is to get cash as soon as possible from sale of the farm and from application for CPP benefits.
Under revised rules for taking early Canada Pension Plan benefits, payments are cut by 0.6 per cent per month for each month prior to age 65 at which benefits begin. For starting benefits at age 60, the total penalty is 36 per cent of the age 65 benefit. The new rules, effective as of January 1, 2012, will be fully phased in by the time the couple retires.
Whether to take benefits now or later is a question of financial philosophy, tax rates and life expectancy. Allowing for the phase in, with the reduction growing by .002 per cent per year until they reach 0.6 per cent, the cost of early application is about $200 per year or $17 per month. On the other hand, having the money now, even in a reduced monthly sum could mean a higher lifetime total benefit, depending on how long Susie lives. And, the benefit reduction can be reduced by investment returns.
If Susie were to invest the full amount of the CPP benefit, about $360 per month or $4,320 per year, and obtain a return of four per cent from stock dividends or corporate bond interest, the net cost of early application would be reduced to two per cent or $8 per month. This is the price of a couple of coffees and buns. Common sense should take over, Forbes suggests. The same advice goes for Jack. The CPP benefits are small in each case, so the penalties for early application are also small. “Take the money, give up a coffee or two if you are concerned, or have a couple of coffees as prizes for making the decision to take the money. Liquidity — in both senses — wins over maximizing CPP income at this point.
In five years, the couple will have CPP benefits totaling $790, Old Age Security benefit of $540, Jack’s RSP/RRIF income of $1,700 per month and Susie’s RSP/RRIF income of $1,166. This amounts to a total retirement income of $4,196 per month in 2012 dollars. Their monthly expenses are estimated at $4,875, leaving a deficit of $679 that they will have to cover from their investment portfolio, which will be about $1.4 million by then.
Managing asset sales and taxes
Before death triggers a final sale, Jack and Susie will have to sell more farmland in order to raise $300,000 for a condo. Fortunately, because they have farmed the land, the sale of the land would qualify for up to $750,000 Qualified Farmland Capital Gains Tax Credit for Jack and a similar amount for Susie. The total credits for two people will be $1.5 million, sufficient to cover all but $100,000 of the estimated sale price of the 640 acre parcel. If the land were all sold before the year in which each turns 65, there would be no effect or trigger for the Old Age Security Clawback which currently begins at $67,688 per year.
In 10 years, when Jack is 65 and Susie is 70, they will have substantial assets. Sale proceeds from the 640 acre parcel of land will be invested in non-registered financial assets which will grow to an estimated $1.8 million. Add in an estimated $286,000 for RRSPs, $124,000 for Tax-Free Savings Accounts, and $400,000 for the condo with a few years of estimated appreciation and they will have $2.6 million in total assets. With no liabilities, their net worth will be the same amount.
In preparation for retirement in five years, the couple can take a series of eight steps to build and protect income and assets.
- Sell farmland for $400,000 per quarter each year.
- Jack and Susie should each make a $20,000 RRSP contribution after the sale each year.
- Jack and Susie should each put $20,000 into TFSAs in 2012.
- Reserve $300,000 from land sales for the condo purchase, putting the money into so-called high interest savings accounts or short term GICs.
- Jack should apply for CPP in 2017 when he is 60 and both he and Susie are retired and in lower tax brackets.
- Jack and Susie should each apply for OAS when they are 65.
- In 2018, when Susie is 65 and Jack is 60, each should convert the RRSP to an RRIF.
- Jack and Susie should update their wills.
In retirement, it will be important for the couple to maintain income. Their present portfolio of mutual funds is 90 per cent equity and 10 per cent fixed income. That should be switched to a 60 per cent fixed income, 40 per cent stock portfolio with adjustments every five years to bring the ratio of fixed income to Susie’s age. By 2022, when Susie is 70, therefore, the portfolio would be 70 per cent fixed income. In 2032, when she is 80, the portfolio would be 80 per cent fixed income.
“It is important to reduce risk and investment volatility as one gets older,” Forbes says. Raising fixed income — bonds and solid dividend stocks — is a progressive process that needs to be maintained as a discipline to ensure the integrity of the portfolio,” he adds.
“Jack and Susie are in the fortunate position of having the means and the mindset to enjoy their retirement,” Mr. Forbes says. “By taking time five years before retirement to plan a tax-efficient and stress-free path to that retirement, they will have a better quality of life than when they were working. The farm will have to be sold to finance that retirement, but the loss is sentimental. Given that their children don’t want to farm, sale is the best and really only choice they have.” †