Dale Williams, 58, and his wife, Moira, 56, farm 10,000 acres in Saskatchewan with their son Michael, 32, and his wife. They have two other children, ages 30 and 26, neither of whom are part of the farm nor want to be. The names we’re using are, of course, fictional to protect the privacy of the family. But their dilemma of how to pass on a farm to the next generation when the capital value of the farm may have to be divided several ways is very real.
Dale and Moira produce wheat, barley and oilseeds along with some field peas. Their farming corporation owns 3,360 acres and they rent 6,720 more acres. The operation is a success, though its profits have understandably been volatile. “We made money in 2008, less in 2009, but we have a $1.5-million pile of debt that we have incurred for expansion,” Dale explains.
Planning for the succession began in 2008 when Dale and Moira arranged for Michael and his wife to come back to work full time on the farm. The parents reorganized their family farm corporation by doing a partial estate freeze. That converted $500,000 of corporation common shares into fixed-value preferred shares. The transaction reduced the value of common shares and enabled Michael and his wife to buy 48 per cent of the common stock at a reasonable price. Michael and his wife will receive a salary for work on the farm and 48 per cent of future growth of the farm’s common stock.
The transactions so far would seem quite routine, but the large amount of farm debt and the interests of the non-farming children complicate what should be a fairly straightforward transition of ownership.
Dale and Moira, recognizing the issues, went to Don Forbes, a farm financial planner with Don Forbes &Associates/Armstrong &Quaile Associates of Carberry, Man. with specific concerns. Will the parents have enough money to retire by the time Dale is 65? What changes are needed to keep the farm succession going while creating a legacy for the non-farming children? What goes to Michael and the other children will not go the parents’ retirement, Forbes notes.
The first step is to determine what cash resources Dale and Moira will have.
Dale has a Locked in Retirement Account with a current market value of $200,000. It should generate $1,360 per month beginning in 2018. He should also receive Canada Pension Plan benefits of $707 per month at age 65 or $495 per month if he begins to take benefits at age 60. At age 65, he will be entitled to full Old Age Security benefits of $517 per month. All sums are in 2010 dollars. We are using current CPP benefit reductions for early application; those reductions will grow from 0.5 per cent per month for each month prior to age 65 at which benefits begin to 0.6 per cent per month for early application,
Moira has an RRSP with a market value of $29,000. It will produce $250 per month of income beginning when Dale is 65. She will receive CPP payments of $475 per month if she begins benefits at age 65 and $295 if she begins benefits at age 60. She will also be eligible for Old Age Security benefits of $517 per month beginning in 2020 when she is 65. She is also eligible for a defined benefit pension from previous employment of $830 per month, Forbes notes
Summing up, if Dale and Moira wait to 2018 to retire, they would have $4,656 per month or $55,872 per year in pension income. With pension splitting that would see Dale’s larger RRIF income taxed partially in Moira’s hands, their taxes would be no more than $6,000 per year or $500 per month, leaving $4,156 per month for spending. This cash flow would cover their expected monthly expenses of $3,200 and leave a surplus for a new car and occasional travel, Forbes notes. And on top of this pension income, their remaining shares in the farming corporation could have dividends. Unfortunately, retirement before 2018 would not work well, for the farm would have too much debt left.
If Dale and Mora want to retire early, the farming corporation would have to cover any shortfall between expenses and pension income. The corporation could continue to pay a salary or dividends on preferred shares or redeem some of the parents loans to the farm corporation, Forbes explains.
MA KING THE SU CCESS ION PLAN WORK
Michael and his wife have a substantial stake in the common shares of the business and therefore have a strong incentive to succeed. He is experienced in managing many farm operations. He has a strong likelihood of succeeding as an owner. Michael will, nevertheless, face challenges in coping with the farm’s debts
There is $2 in equity for every $1 in debt right now. The debt is financed on a variable rates at an average rate of 6 per cent, Dale notes. If interest rates appear ready to rise several per cent or if grain prices are likely to drop, the farm could lock in loan rates at today’s low numbers or take steps to sell some assets to cut loans. The latter move, Forbes notes, would increase the farm’s ability to borrow more money in future.
The farming corporation is dependent on Dale, Moira and Michael. Currently, Dale and Michael have $500,000 of life insurance coverage each. It would be a good idea to boost that coverage to $1 million each just to cover farm corporation debt, which stands at about $1.5 million. Premiums would be $86 per month for Michael for a 20 year term. Dale’s policy could cost $375 per month for a 10-year term. Adding up the premiums, they would cost $5,532 per year. That’s just two-tenths of one per cent of gross farm revenues for their own and their lenders’ peace of mind, Forbes says.
The remaining question is what to do to help the two children who don’t want to farm. One approach is to ask what they would receive were the farm to be sold today.
Their interests could be covered quite substantially by a separate $1 million joint and last-to-die insurance policy on the parents’ lives. The policy would cover the present net worth of the farming business shares remaining in the hands of the parents. The $7,000 annual premiums would be paid by the family forming corporation with proceeds at death flowing back through the corporation’s capital dividend account and then to the non-farming children. Michael would still come out with full ownership of the farm business and its land. The proceeds of the insurance policy plus other non-farm assets would give the non-farming children $650,000 to $700,000 each, Forbes estimates.
Dale and Moira should also begin contributing to Tax-Free Savings Accounts. It is a very easy way to shelter money they get from the farm. Unlike RRSPs, which defer taxes and then subject payouts to many rules, TFSAs use tax-paid money and then subject payouts to no rules at all.
“Overall, the farm succession is going well,” Forbes says. “They have high expectations, but there is every indication that Michael can live up to them. Dale and Moira started with 2,000 acres and Michael will start with five times that. That’s a big jump, but Michael should be up to it.
“The couple can have a comfortable retirement, but they can and perhaps should reward themselves more in their retirement,” Forbes suggests. “It is their hard work and business management skills that have produced their very successful farm. They have lived frugally and been reluctant to spend much money on themselves. The easiest way for them to get more money out of the farm would be to have the corporation repay some of their $500,000 shareholder loans out of free cash flow when it is available. The balance sheet would have to be protected, so that other lenders would not balk.”
“This is a good plan, but we would have some trouble finding the money to pay life insurance premiums right now,” Dale says. “But when our crop prices go up and we get more cash flow, we can put this succession plan into effect. And there is the final variable, which is how much we owe our kids.”
AndrewAllentuckisauthorofWhenCan IRetire:PlanningYourFinancialLifeAfter Work,publishedin2009byVikingCanada.