Looking at their options early will help ensure a bright financial future for this young farm couple
Out on the Prairies of western Manitoba, a couple — we’ll call them Herb, 30, and Sally, 28, are building their lives on a 500-acre farm they own and Herb’s 17 per cent share in a 2,500 acre family farm. Sally has a town job — she works in a bank and pulls down an $80,000 annual salary. Herb takes $12,000 per year from his own farm and another $18,000 per year from the family farm. Their combined income is $120,500.
Their business is cereals, edible beans and 80 beef cows. The two farms, both organized as family farm corporations, are profitable, but the couple has a $128,000 debt to Sally’s parents for money borrowed to buy their $200,000 house. Add in $80,000 of other real estate including a rental home that brings in $300 per month of income and take off $52,000 of other loans, and with their Registered Retirement Savings Plans and other registered assets and they have a net worth of $473,400. Not bad for a young couple just starting life together.
Their plan for now is to pay off their debts and build up their bank accounts for the kids they expect to have one day. They appreciate the financial complexities of their lives. To sort out their choices and to build a strategy for managing them, Herb and Sally asked Erik Forbes, an associate with Don Forbes Associates/Armstrong & Quaile Inc. in Carberry, Manitoba, for guidance.
The couple’s choices, Forbes says, are extensive. But they have done the right thing, using an operating corporation as an umbrella over the farm. The corporation pays tax at a rate of of just 11 per cent. The money that would otherwise be taxed at higher personal rates stays in the company and can be used to invest in equipment or other assets to grow the farm. The farm’s assets will be exposed to capital gains tax when sold, but, as Forbes notes, there is an $800,000 personal lifetime superexemption that can shelter much capital gains tax.
In several decades, when the couple retires, it will be easier to sell land than shares in a personal corporation. So future purchases of land should be in the couple’s personal names. They can lease the land they own to the corporation.
The problem with using the corporate umbrella is that money is hostage to income tax which is payable when drawn as salary. But tax can be minimized if money is transferred to RRSPs, as, in fact, Herb has done. Sally uses her own RRSPs for her combined farming income and bank salary.
Life, in the financial sense, has several well defined stages. The first, buying a home, has been achieved with a relatively small debt. Next comes family formation and, finally, retirement.
Saving up for post-secondary education for children will be facilitated with Registered Education Savings Plans. If they deposit $2,500 per year per child, get the Canada Education Savings Grant of the lesser of 20 per cent of contributions or $500 per child and obtain a three per cent return after inflation, by each child’s 18th birthday, the account would have $67,240 per child, enough for tuition and books at any local institution for four years.
There are no children yet, but Herb and Sally need to make sure that if either passes away prematurely, the children to be will not be without resources. To that end, Herb should get a 10-year term insurance policy with $1 million in death benefits.
He does not smoke and, at his age, the premium would be only $50 per month. The policy would cover outstanding balances on loans to Herb and/or his corporation.
Sally has $150,000 in term coverage as part of her employment benefits. She should increase the coverage with a policy of her own. If she were to buy $500,000 of death benefits, then at her age as a non-smoker, the annual premium on a 10-year level term policy would be $20 per month.
Planning retirement 30 years in the future is speculative, to say the least, but it nevertheless illuminates the process by which Herb and Sally will move from the beginning of their financial lives to the time at which they can switch from toil to leisure.
At present, Herb and Sally have $33,000 in their RRSPs and $29,000 in their Tax Free Savings Accounts. If they add $6,188 this year and increase their contributions at three per cent after three per cent annual inflation and maintain this savings flow for 30 years, then at Herb’s 60th birthday, the couple will have $2.7 million in combined RRSP and TFSA deposits.
Their non-registered funds, currently $30,000, would rise with contributions and interest to approximately $72,000 in the same period. The combined sums, $2,772,000, could generate $83,160 at three per cent per year or $6,930 per month before tax.
At age 65, each would be entitled to Canada Pension Plan payments that can be estimated at 86 per cent of the maximum $1,012.50 per year or $860 per person, $1,720 per month total.
At age 67 each would be entitled to receive Old Age Security, currently $546 per month for total income of $9,742 per month.
After 20 per cent average income tax, they would have $7,794 per month to spend.
There are many risks in this projection. Retirement income depends on the couple maximizing RRSP and TFSA contributions each year, Forbes notes. Security for the family, at least in the early years of children’s lives, will depend on purchase of what is now very inexpensive term insurance. Their RRSP and TFSA investments must grow efficiently, that is, without excessive investment or management costs.
Exchange Traded Funds are part of the answer as are higher fee mutual funds that the couple may choose for their strategies or their track records. The couple must have wills prepared along with enduring powers of attorney which can assist either partner to run the farm if one is incapacitated.
A final challenge will be the integration of Herb and Sally’s own farm with their interest in the larger family farm. Succession plans for the larger farm should be integrated with their own both for tax reasons and to ensure family harmony. A plan to distribute shares of the family farm at the death of any owner should be considered as well.
A trust structure to hold shares of the family farming corporation would allow the continuation of the family farm without sales of actual land or other assets. The trust could also be used to control the flow of income and tax exposure. The trust or a series of trusts might, subject to suggestions by the Minister of Finance that family trust structures used for income averaging may be subject to review, also reduce aggregate taxes paid by family members.
“This couple has made an excellent start to good money management habits which will last them a lifetime,” Forbes says. “By starting now with good financial strategies, they will be prepared when, inevitably, financial challenges occur.” †