Grainews is looking for farmers with troublesome financial questions. We will protect your privacy. We insist on examining real situations, but we DO NOT use real names or even identify your hometown. You do not have to pay to participate in this article. If you have a financial question, send your name and your question to the editor, Jay Whetter, at 807-468-4006 (phone), 807-468-4588 (fax) or [email protected]Grainews will contact you if we want to follow up.
Thanks Don Forbes of Carberry, Man., for his help with this report. You can contact Don at 204-834-3155 or [email protected]
A couple we’ll call Jack and Suzie farm 4,000 acres in Manitoba. They are the third generation of the family farm. They have 600 beef cows on 3,000 acres of summer pasture and 400 acres of cropland, usually sown to field corn.
Jack and Suzie, ages 64 and 62 respectively, have come to the point where they have to think about passing the farm on to their three children, all in their 30s. They want to do it with as little fuss as possible. That means no corporate lawyers and no fancy finance.
Like a lot of other farms, Jack and Suzie’s operation has tied up a lot of capital — as much as $518,500 — yet produced relatively little income. For 2009, the farm should generate $45,700 income before tax. Clearly, Jack and Suzie have to raise their returns from the operation as well as to find a way to pass it on to their kids.
Farm Financial Planner asked Don Forbes, head of Don Forbes & Associates/Armstrong & Quaile in Carberry, Manitoba, to work with Jack and Suzie to devise ways to accomplish those goals.
“The first stage of the plan is to ensure that the ongoing cattle operation can sustain the three family units for the parents and the two sons,” Forbes says. (The daughter’s legacy will come from a life insurance payout from her parents.)
The second is to raise the productivity of the farm by improving the beef yield from grazing and by switching the calving season from April to June. That will raise milk production and put on more pounds of beef. It would also be a good idea to aim for a beef cow of 1,200 pounds, a good weight for their Angus and Galloway breeds that winter outdoors better than Charolais that they have used in the past. Moreover, Angus and Galloway tend to need less maintenance than exotic breeds. At 1,200 pounds, Angus and Galloway have what has been shown as the best weight gain per acre. The idea is to get the most beef per acre of grazing rather than to grow the biggest animals, Forbes explains. Last of all, the key to the long-term sustainability of the farm is to continue to use their present 400 acres of field corn as winter grazing for their herd. This way, with summer grazing and winter corn, Jack and Suzie will have sufficient feed for 50 weeks of the year, Forbes says.
Jack and Suzie also need to restructure their finances. Their goal should be to make the most of the $750,000 qualified farm and property exemption. If they deem to sell the property to their farming children at today’s market value, Jack and Suzie can write off a capital gain they estimate at $210,000. There would be no income tax payable on the transfer. The book value of the received farmland would be today’s market value. Their sons, who are intended to carry on the farm, would have to borrow the money to pay their parents.
But Jack and Suzie would rather give the farm to the boys, not to saddle them with debt. They can just gift the farm to the sons at
today’s market value and avoid all taxes except for a small land transfer tax. The sons in effect are paying for the farm. The payment will take the form of cash flow to the parents and will not be a lump sum from a sale. The parents actually do get the equivalent of a profit this way, because the sons will pay in addition to the farm’s bills the costs of upkeep, hydro and other utilities for the parents’ on-farm house. The farm kills its own beef and the parents will share in that, too. The result is like a sale. After the land transfer to the sons, the parents will have lifetime income and benefits. In theory, these non-cash benefits would be taxable, Don adds.
Another option for transfer of the farm is to crystallize its value today. The easiest and least demanding way to do that is to write a partnership agreement that specifies who does what on the farm. Then all operating lines of credit — there are three — should be consolidated into one account. Monthly statements should go to each family member, Forbes suggests.
These monthly consolidated statements will make farm operations more transparent. Once the cash flows from the cattle operation and crops are clear, a new reporting system can be created. Within the farm operation as a whole, there should be one line of credit for cattle operations and another for farm machinery purchases. This machinery line of credit can take the form of medium term (say five year) notes at negotiated rates of interest. The last business is the land itself, which can be sold or remortgaged on long-term loans.
As Jack and Suzie move toward complete retirement, they need to firm up their farm cash flow and off-farm income. The farm itself provides $1,000 a month of taxable benefits. Jack is collecting $594 per month from the Canada Pension Plan. Suzie will get $200 per month from CPP when she applies. Jack and Suzie will each receive $517 per month from Old Age Security. That’s a total of $2,828 per month.
To boost that income, their children should buy them a joint and last to die annuity that pays them $1,000 per month. The annuity will cost $150,000 and can be financed with a loan against farm assets. The first $4,000 of income from this pension will be tax exempt. The grand total of their farm income, CPP, OAS and the annuity will be $3,828 per month or $45,936 per year. That will be ample provided that Jack and Suzie continue to live on the farm, Forbes says.
If Jack predeceases Suzie, she will get a $500,000 death benefit from a life insurance policy on Jack’s life. That money would allow her to move to town and part of it, about $150,000, could be a legacy for their daughter with the balance eventually paid to the sons. The sons will get the farm. Jack and Suzie have yet to decide what happens if Suzie dies before Jack. But in the end, they intend that a third of their insurance go to the daughter and the balance to the sons.
Jack and Suzie will have a comfortable though not lavish retirement. If they draw as little as three per cent or $2,460 of their $82,000 of off-farm financial assets early in retirement, their portfolio will stagnate. The problem is that their investments, mostly guaranteed investment certificates, have a very low rate of return. If Jack and Suzie can raise that return by a few critical percentage points, they will be able to have their income and some asset growth as well. They can use Tax-Free Savings Accounts for their GICs and cash for annual contributions of up to $10,000 for the couple. Withdrawals are without tax and can be made at any time.
Studies of long-term asset growth show that it is very difficult to produce a return over six per cent with common stocks over the long run. Government bonds and GICs return about three per cent per year. Investors who are experienced in the stock market can do a lot better, but Jack and Suzie have never wanted to take on stock market risk. As well, aiming for double-digit returns means taking chances that could wipe out their savings. It would be the wrong thing to do.
But the couple can build in a higher rate of return than common stocks and stock mutual funds offer and far more than guaranteed investment certificates pay at the present. Investment grade corporate bonds issued by the biggest names on Bay Street currently pay average returns in a range of six to seven per cent. That’s more than the 3.7 per cent average annual compound return generated by Canadian equity mutual funds for the 10 years ended February 28, 2009.
Corporate bond investing is a special skill. Bonds are bought and sold over the counter without uniform pricing. At any one moment, prices can vary among sellers and buyers. There are questions of credit quality, promises in the bond contract and other complexities. Rather than sort through these issues, Jack and Suzie could buy a bond mutual fund or a bond exchange traded fund such as Barclay’s basket of corporate bonds that is traded on the Toronto Stock Exchange under the symbol XCB. The ETF trades like a stock and is therefore priced everywhere at the same amount at any moment. XCB and other exchange traded funds have management fees that are a small fraction of those charged by actively managed mutual funds and, indeed, by most index-type mutual funds. There is no need for Jack and Suzie to become speculators, but they should consider this very conservative way of boosting their interest income, most of which now comes from GICs, Forbes suggests.
Migrating some of their money out of GICs and into negotiable bonds and even into a few conservative stock funds is essential,
for over the two or three decades of retirement, Jack and Suzie will have to cope with inflation. If prices rise at three per cent per year, their portfolio will simply stagnate. Yet in spite of the financial advantage of adding some negotiable bonds or perhaps a small amount of stock exposure to their portfolio, Suzie prefers to stick with what she regards as the safest thing available — government-insured GICs.
“If we have $50,000 we want to know it’s there,” Suzie says. “We don’t want to risk any loss. And if the interest we get is not much, we accept that.”
Andrew Allentuck’s latest book, When Can I Retire? Planning Your Financial Life After Work, was published by Penguin Canada in January 2009. It’s available in bookstores across Canada.