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, Andrew Allentuck, at 204-488-7248 or [email protected]Grainews will contact you if we want to follow up.
In southeast Saskatchewan, a couple whose names we’ve changed to Martha and Phil have been struggling to keep a farm in the family. Phil’s grandfather started the farm as a homesteader on a quarter section in 1900. Currently, Phil, who is 61, and Martha, who is 55, own 520 acres and lease another 1,334 acres for a total of 1,854 acres. They have three children — one in his early 30s, one in her late 20s, and a son not long out of high school. All would like to stay on the farm.
Their operation, a custom grazing set up, produces operating income after expenses of just $8,000 per year. In order to support the farm, Martha and Phil do off-farm work. Martha does a variety of jobs and brings home $5,400 per year. Phil drives a truck and brings home $60,000 per year. That total income, $73,400 per year before tax, isn’t a lot to support Phil, Martha and their youngest child, who still lives at home.
Farm Financial Planner asked Don Forbes, head of Don Forbes & Associates/Armstrong & Quaile Associates Inc. in Carberry, Man., to work with Martha and Phil in order to raise family income and help keep the farm in the family. As he sees it, the farm’s financial problems began three decades ago when Phil’s dad passed away. The farm was then divided among Phil’s brothers and sisters with the condition that each sibling be paid his share of the business.
A NAGGING MORTGAGE
The payout began the farm’s problems. It was 1980 and interest rates for bank loans and mortgages were in the mid-teens. The loan was unsupportable and the mortgage the couple took has been extended several times in spite of their efforts to pay it off. Today, though interest rates remain near historic lows, the damage has been done.
There remains a $40,000 mortgage that is tough to service out of current cash flow.
“The family had to sell off parts of the farm. But they always kept the mineral rights,” Forbes explains. “Last year, oil wells were drilled where they had those rights. The wells turned out to be productive and last year, the family got its first royalty cheque for what should turn out to be $30,000 per year.”
That’s the good news, but the bad news is that Phil’s off-farm job isn’t quite secure. Feeling that their luck was about to run out, the couple sought advice.
“The questions they asked were how they could keep the farm in the family for another generation and whether it was still worthwhile to keep investing in it,” Forbes says.
The answer, in brief, is that the farm is not sufficiently profitable as a custom grazing operation to be sustainable. “It is now a rural lifestyle rather than a business,” Forbes notes. But that does not mean that it cannot be kept in the family. First step — have a family meeting to establish the goals for the farm. Given that the farm is not financially sustainable, should Phil and Martha sell out, keep the oil royalties, and move to town?
The numbers provide the answers, Forbes says. If Phil and Martha keep their off-farm jobs, continue to run the farm as a custom pasturing operation, accelerate payment of the mortgage down to $10,000 or less, work five more year off the farm and maximize use of tax shelters, they should be able to keep the farm.
If Phil continues to earn $60,000 a year off the farm, he should be able to put $5,000 per year into his own RRSP and $5,000 into a spousal RRSP for Martha.
They can also try to make the most use of their Tax-Free Savings Account space which amounts to $10,000 for 2009 and $5,000 per person in 2010 and subsequent years.
Phil’s off farm job will provide a base for more Canada Pension Plan contributions. That will help to generate pension income when he applies for CPP benefits, Forbes explains.
In five years, when Phil is 66, he will have total pre-tax retirement monthly income of $543 from Old Age Security (assuming that present payments of $517 per month grow with inflation), Canada Pension Plan payments of $300 per month, oil well royalties of $2,500 per month, Phil’s $250 per month income from his Registered Retirement Savings Plan, and Martha’s RRIF income of $250 per month. Add in net farm income (we allow for modest growth assuming that beef prices rise) of $800 per month and the family’s total monthly income should be $4,643 or $55,716 per year.
Divided into two hands, taxes on total income should be in a range of $1,000 to $1,500 per year per person, depending on tax rates that will prevail in future, the personal exemption applicable, and pension income credits that are now $2,000 per person per year. Their after tax income will therefore be about $52,000 per year. That income will rise when Martha begins to receive Old Age Security benefits at 65, adding $570 per month in future dollars to income for a total of $5,213 per month (including an inflation boost for Phil as well) or $62,556 per year.
Assuming that living expenses are $2,900 per month or or $34,800 per year, Phil and Martha can retire on the farm and keep it in the family, Forbes concludes.
HOW TO KEEP THE FARM
There are two ways that Phil and Martha can assure that the farm will stay in the family for the next generation without the need for the heirs incurring substantial debt. Before oil well royalties began to roll in, the couple would have had to take out a joint and last to die life insurance policy. Assuming that the farm, equipment and home have a value of $300,000, a term policy with premiums fixed to age 100 would have a premium of $2,870 per year or $240 per month plus a small charge for time payments.
Life spans are increasing, so the policy might have had to have been supported for three decades. The cost of 30 years of life insurance coverage would be $86,100, more than a quarter of the death benefit.
The oil wells on their property offer an alternative way to finance the farm’s transition to the children. If Phil and Martha put $5,000 into each of their TFSAs in the next twelve years at four per cent annual interest, they will easily build up enough money to cover the value of their pasture, now worth about $200,000. If they maintain this rate of saving and growth, the TFSAs would have a value of more than twice the present worth of the farm, Forbes estimates.
Phil and Martha should update their wills and ensure that their children have shares of their royalty income. A family trust could administer those royalties to ensure equal treatment of each child, Forbes says.
“They are fortunate in that the proverbial oil well has materialized,” he explains. “Otherwise, the farm would have ended on their watch. Phil will have to work another five years for additional cash flow to make the plan work. But they can have a comfortable retirement while still passing the farm on to their children.”
Andrew Allentuck is author of When Can I Retire? Planning Your Financial Life After Work, published in 2009 by Viking Canada.