Central Manitoba farmers Lloyd, 59, and his wife Ellie, 58, have been running their grain farm for four decades. With 1,920 acres of land they own personally and 960 acres in their farming corporation and reasonably up to date machinery owned by the corporation, they face the common problem of generational succession.
They have two sons, Dave, 35, and Charlie, 30. Dave is married with two children. He works in the family farm business, helping with management and hands-on chores. One day, he and his parents figure, he will take over the farm. He has 480 acres of his own nearby. Charlie developed his own off-farm business. Lloyd and Ellie figured that, if Dave got the farm in a generational transfer, Charlie should get some compensation. Duly, Lloyd and Ellie bought a $2 million joint and last to die life insurance policy with the intention that Charlie would be the beneficiary.
Things have changed. Charlie now wants to get back to farming. He rents land nearby and uses the family farm corporation’s machinery. He wants to be part of the generational transfer and have a piece of the whole family farm business through a buyout.
Adjusting to a new reality
Now it’s necessary to carve up the family estate while protecting the interests of the parents and each of the children. According to farm financial planning experts Don Forbes and Erik Forbes of Don Forbes & Associates of Carberry, Manitoba, eight of the nine personally owned quarters can be transferred to Charlie and one to Dave. The transfer can make use of Lloyd and Ellie’s qualified farmland capital gains exemption of $1 million each to bump up the value of the land up on transfer. The adjusted cost base would be increased by $2 million with the realization of the balance of any market value to be deferred until Charlie wants to sell or transfer his interest in future. The transfer will probably incur the Alternative Minimum Tax and modest provincial tax. The largest part of the transfer will be tax free.
Charlie will gain clear title and he will take back a zero interest promissory note for the transfer value registered against the land tittle. The note will require no periodic payment.
This structure allows Charlie to control his land, and to participate in any future gain in value of the land. The structure does not require him to borrow money to purchase the land outright. If he did have to come up with money, his cash flow would probably be impaired, Don Forbes notes. The promissory note would be structured to be forgiven on the death of the surviving spouse after the first passes away. The promissory note would protect Lloyd and Ellie. Charlie would be required to pay fair market rent as a basis for Lloyd and Elsie’s retirement.
Life insurance is both the mechanism for transfer of capital value and the backstop for value contained in the land transfer. The parents should keep their present joint and last to die term insurance policy. The payout of the policy on the death of the last parent will provide a legacy for the children. Currently, premiums are $17,819 per year, which Lloyd and Ellie are paying personally.
Lloyd and Ellie are considering building a town home. It would be a single level structure with good access for handicapped persons, e.g., a wheelchair ramp, wide doors, etc., the house will be liveable for the parents should they develop disabilities, will be rentable, or could be sold for what is likely to be an appreciated price. Call it a flexible investment, it’s a future cost with a built in gain or, if they use it themselves, a preliminary to selling their present farm house.
An existing mortgage due to be paid in full in just a few months could be re-amortized and then used to pay for new home construction. If the farming corporation guarantees the loan, the lender will have a secured interest. The farm corporation could advance funds. Lloyd and Ellie should pay interest to the corporation at the Canada Revenue Agency prescribed rate, currently one per cent per year.
Assuming that Lloyd and Ellie work for six more years to Lloyd’s age 65, then his present balance of $247,000 in RRSPs growing at $12,000 per year with a 3.6 per cent rate of return will rise to $387,000 and support annuitized income of $1,500 per month for 35 years to his age 100. Ellie has $219,000 in her RRSP and will also add $12,000 a year for the next six years. At that time, her RRSP will have a value of $352,400. Annuitized, that capital will support benefits of $1,500 for 36 years.
For Lloyd, income will consist of $581 per month anticipated Old Age Security using 2016 values, Canada Pension Plan benefits of $590 per month on the same basis, and income from RRSP of $1,500 per month. Ellie can expect $581 per month Old Age Security benefits at 2016 values, Canada Pension Plan benefits of $590 per month, $1,500 in monthly annuitized investment payments and $10,000 of land rental payments. The total of these sums would be $14,819. Tax would be approximately $4,200 per month, making disposable income $10,619 per month or $127,428 per year. That would support at very pleasant way of life in their new home, travel and new vehicles from time to time, Erik Forbes notes.
Accumulation of savings should be done within Tax-Free Savings Accounts. At present, neither Lloyd or Ellie has a TFSA. The limit at time of writing is $46,500 per person and will grow at $5,500 per year. Rules for withdrawal and contribution are simple, unlike the complex rules for RRSPs.
A final suggestion, Don Forbes says, is to transfer several RRSP accounts to one institution and to switch out of mutual funds, which have average fees of 2.6 per cent per year, to exchange traded funds with average fees as low as 7/100 of one per cent. Most bond and stock ETFs have fees in a range of one to two fifths of one per cent for plain vanilla major market index funds. The savings on fees would wind up in Lloyd and Ellie’s pockets. If they save two per cent a year on fees, over the 35 years of our projections, the couple would save as much as 70 per cent of what would amount to a rising asset base. Fees tend to be lowest on the simplest ETFs, that is, those that replicate major market indexes. The couple should take independent investment advice with a view to achieving a diversified and cost effective portfolio, Erik Forbes suggests.
“This couple’s farm business has been very successful,” Don Forbes says. “The process of transferring assets will ensure that each son gets a strong ongoing business, that taxes that are paid are reasonable, and that the entire process is self-sustaining and insurance-backed. It is package of relatively simple concepts. With the assistance of Lloyd and Ellie’s lawyer to draft suitable will and to review these recommendations and their accountant to ensure the tax implications of the restructuring are as anticipated, the couple and their children will have asset security, acceptable tax costs, security in the process of generational transfer and backstops should some circumstances change. It is a secure plan.”