Given the importance of basic financial literacy, it seems a valid question. I would readily admit I am far removed from the education system and don’t really know what is being taught; however, based on what I have observed there seems to be a lack of such skills. With that preamble, I thought it worth stepping back to a couple investing basics. The Rule of 72 is a simple mathematical oddity that works. If you divide the rate of return into 72, that’s how many years it will take to double your money. If you earn a three per cent return it will take 72÷3, or 24, years to double your money. If you earn six per cent you will double in 72÷6 or 12 years, and if you earn 12 per cent you will double in six years.

I use those numbers for illustrative and easy math, but they are also fairly reflective of the very long-term returns on cash, bonds and stocks of 3.4, 4.7, and 9.5 per cent respectively. While 12 per cent will be scoffed at by many as an unrealistic return rate, my personal record is very close to this.

READ MORE: Five tips for better year-end financial planning

The second part of the simple math exercise is this: if you invest $1,000 when you are 20, how much will you have at a retirement age of 68? I am again using this 48-year timeframe for easy and illustrative math.

If it takes 24 years to double, then an investor will achieve two doubles or $1,000 x 2 x 2 = $4,000. If it takes 12 years to double, then the investor will double four times or $1,000 x 2 x 2 x 2 x 2 = $16,000. If it takes six years to double, the investor will achieve eight doubles or $1,000 x 2 x 2 x 2 x 2 x 2 x 2 x 2 x 2 = $256,000. This is the power of compounding.

The third part of this simple math exercise is to recognize that long-term inflation has run about three per cent. Investments are impacted by inflation and taxes. There are far too many nuances around taxes to address but we can easily factor in inflation. This historical inflation rate would take a three per cent return to a zero real rate of return, a six per cent return to a three per cent real rate, and a 12 per cent return to nine per cent. Therefore, the first investor after 48 years would have his original $1,000 but that’s all. The second investor would have two doubles, or $4,000 and the third investor would take 72/9, or eight years to double, and in 48 years would achieve six doubles, or $1,000 x 2 x 2 x 2 x 2 x 2 x 2 = $64,000 real return. Which outcome would you prefer?

The “cost” of saying you would prefer the latter outcome is the learning that is required — and the fluctuations that need to be endured.

Happy returns

Calculating your personal return rate is another simple but critical step to take. I do this across all TFSA, RRSP and taxable accounts at year-end. If you haven’t done this before, it would be a worthwhile exercise to go back as many years as possible. Most internet investing sites calculate return rates, but I believe some learning will occur if calculated on your own.

If someone started the year with $10,000 and ended the year with $12,500, the gain would be $2,500÷$10,000 invested, or 25 per cent. However, we must also account for fund flows in or out of an account. This makes the math a little more difficult, but still relatively easy. Let’s work through an example of how I do it.

If an account starts with $10,000 on Jan. 1, and you add an additional $2,000 on May 1, but take $1,000 out on Nov. 1 and end up with $12,500 at year-end, what return rate has been achieved? We must calculate the gain, as well as the average amount invested during the year. The gain is easily calculated: $12,500 – ($10,000 + $2,000 – $1,000) = $1,500.

The average investment is more difficult but still straight-up math. We had $10,000 invested for 12 months, an additional $2,000 for eight months and subtracted $1,000 for two months. The average is: $10,000 x 12 + $2,000 x 8 – $1,000 x 2, all divided by 12 months. This works out to $11,167 average invested over the year. Our gain was $1,500 so our return rate was $1,500/$11,167 equals 13.4 per cent.

In school, oh so long ago, I always preferred math over English, so it comes more naturally to me. However, both those important math exercises should be within the grasp of most individuals — and I see no reason why they couldn’t be taught in school.

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Chuck and Liz asked Colin Sabourin, a farm transition specialist with Winnipeg Financial Planning, to help devise an exit strategy. The task is significant in terms of the couple’s $6.435 million net worth, 92 per cent of which is farm assets, and their own preference for avoiding the conventional risks of financial assets like stocks and bonds.

It’s useful to dissect farm assets to determine value and a method of disposal, Sabourin explains. He notes that the farm equipment and buildings have a current value of $600,000 and $400,000, respectively, for a total of $1,000,000. Their combined, un-depreciated capital cost is $657,000, leaving $343,000 as a taxable gain. The couple also have $300,000 of unsold inventory that will be taxable when sold.

$1 million lifetime capital gains exemption

The couple’s farmland is worth $6,600,000. They paid $1,250,000 for it, so their nominal capital gain is $5,350,000. The farm is jointly owned, so the couple can split the capital gain and each partner thus has a $2,675,000 gain. Only half the gain is taxable, so each will have to report a gain of $1,337,500 for tax. Each can take a $1 million lifetime capital gains exemption, this can reduce net income by $500,000 each.

In addition to the business or farm income, they receive Canada Pension Plan retirement pension in the amounts of $6,000 for Chuck and $5,150 for Liz. Each gets Old Age Security (OAS) pensions at $7,380 per year in 2021.

If Chuck and Liz sell all of their farm assets this year, they would each have taxable incomes of approximately $1,161,043 and $1,160,193, respectively, and tax bills of $569,846 and $569,419. Those bills add up to $1,139,265. They would have

$6,760,735 after tax. After paying off debts, they would have $4,775,230 for their retirement. Each would lose OAS in the year of the asset sale, for both would be far over the maximum clawback threshold for OAS of $129,075, when all OAS paid would be gone.

The clawback takes 15 cents of each dollar in the interval between the trigger point, $79,845 this year, and the point at which all OAS is taken back at $129,075 of total income. Added to ordinary income tax, the marginal rate for the combined taxes can be in a range of 50 per cent to 63 per cent. Once all OAS is taken back, the total rate, which is then just regular income tax, drops by 15 per cent.

Chuck and Liz can reduce their tax bills by using Registered Retirement Savings Plans (RRSPs). Chuck has $159,000 of room and Liz $87,000 of room. If each uses up all of that room, they would reduce their total tax bill by $123,894, Sabourin estimates. In subsequent years with much lower incomes, they could tap the RRSPs. In this case, they would save tax at about 50.4 per cent today and pay only 27.75 per cent on future. That’s about a 23 per cent tax savings. Moreover, their OAS could be restored in future years, Sabourin notes.

Qualified farmland exemption

There are two alternative strategies to cut taxes. The first is to use the qualified farmland exemption of $1 million per owner and the second is to shift some assets to a farm corporation in the year of sale.

In the first case, if Chuck and Liz gift the farmland to their daughters, it would be the daughters who would take on the eventual tax obligation when they sell. However, if the daughters hold the land for at least three years and then sell, they can use their own lifetime capital gains exemption.

This strategy would enable Chuck and Liz to shelter $4 million of the estimated $5,350,000 capital gain, twice the $2 million of our first strategy explained above. The parents would walk away with an additional $500,000 after tax.

Incorporate in final year

The final way to shelter farm gains is to incorporate in their final year of farming. At present, all income is attributable to Chuck and Liz. If they incorporate, they can put inventory, equipment and buildings into the corporation and pay only a nine per cent tax on the first $500,000 of income followed by 27 per cent on income over the threshold.

The present taxable income of their equipment, buildings and inventory is $643,000. Selling this personally would incur a $324,072 tax. But via the corporate structure, the bill would be only $83,590. Money would still be in the corporation, but it would be possible to with- draw it slowly when they are in lower brackets and pay only 27.5 per cent on the withdrawals.

The balance is clear. If Chuck and Liz do no tax planning, they will have $4,775,231 from their farm sale. If they do strategic planning, they can save a few hundred thousand in taxes.

What they do with their savings is the next issue. Currently, Chuck and Liz have $145,000 in their RRSPs and $40,000 in Tax-Free Savings Accounts (TFSAs). Not only have they not taken full advantage of these tax shelters, they have invested what is in them in low interest GICs and left a great deal of cash in savings accounts that pay one per cent or so before inflation and minus one per cent to minus two per cent after inflation, Sabourin estimates.

Fixed income investing rewards the patient, but when interest rates lag inflation, a dollar today can become a dime tomorrow. Accordingly, a program of investment in large cap stocks that pay dividends of three to five per cent, as chartered bank shares do, perhaps a low fee exchange traded fund focused on Canadian and/or American shares with annual costs of small fractions of one per cent (compared to an aver- age cost of 2.5 per cent for Canadian mutual funds), or balanced funds with some bonds for backup when stocks sag would give the money they harvest from selling the farm a chance to keep up with inflation.

The results of a program of buy and hold investing in stocks with solid and growing dividends can be estimated from the easy-to-use rule of 72s. Divide 72 by a rate of growth or interest and you get the number of years it takes a sum of money to double. For example, for a four per cent rate of return including dividends, 72 divided by four is 18 years. That would put Chuck and Liz at ages 86 and 84. For stocks with a five per cent return rate, money would double in 14 years — Chuck and Liz would be 82 and 80.

Picking stocks or mutual funds or exchange traded index funds takes study and advice. In retirement, Chuck and Liz would have time to study capital markets and generate returns commensurate with the time and dedication they put into farming.

They could minimize taxes by using their very large TFSA space so that they might never have to pay tax again on money already taxed before going into the TFSA. Their time for use of RRSPs will end soon, so the TFSA is the best simple shelter available.

“What we have suggested is a clean break with farming,” Sabourin explains. “The couple would have a substantial amount of cash to live on or to invest. That’s a big responsibility for which they might take advice or devote time for study. I wish them well.”

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My longest standing stock account is an RRSP. Many years ago, Canadian RRSPs had foreign content restrictions, forcing investors into Canadian companies. It was originally 10 per cent, increased to 20 per cent, and eliminated in 2005, allowing greater flexibility. The lifting of these restrictions coincided with a decade of currency parity, creating a great opportunity for U.S. investing, which came to represent about two-thirds of my portfolio.

The U.S. is the largest and most diversified economy in the world, with its stock market representing 40 per cent of world markets. It doesn’t tax dividends in retirement accounts, making it the market of choice for RRSP international diversification.

My longest U.S. holding is Microsoft. I originally purchased Mr. Softie for $26.17 in 2002, less than half its peak price in 2000, at the height of the tech and dot.com bubble. In 2006 I added at $22.14. It started to pay a regular dividend in 2003 and paid a large special dividend of $3 in 2004. I have collected over $16 in dividends on the original shares. It has been a lesson in patience. Microsoft didn’t move for a decade, but since 2013 has been on a tear with shares now valued at $120.95, about five times my purchase price. It was becoming such a large part of my RRSP I regrettably sold a small portion about a year ago, yet it still represents seven per cent.

My second longest U.S. holding is JP Morgan Chase, currently the largest U.S. bank. It wasn’t the largest when I purchased it at $20.46 in 2003. I added to my position in 2011, just as the financial crisis was clearing, for $37.80. Today at $111.21, it’s over five times my initial cost. I have collected about $23 of dividends on the original shares. Five times the original price sounds great, but is only about 10 per cent annually. Adding the dividend, JPM has been returning about 13 per cent annually, illustrating how modest returns compound over time.

Do I always buy giant companies? My next example, Medical Property Trust, was a very small U.S. Real Estate Investment Trust (REIT) that owns medical facilities. REITs pay out the bulk of their cashflow in dividends which is OK in an RRSP, without withholding taxes. I purchased at $12.28 in 2007, at $11.83 in 2008 and at $12.16 in 2013. It was paying dividends of $1.08 annually for a 9.1 per cent yield. The dividend was cut to $0.80 in 2008 and has slowly grown back to $1, representing 5.3 per cent yield at its current $18.76 price. Its share price declined to below $3 when “everybody” was panicking during the financial crises. As of today, I am up about 50 per cent on the share price in a decade, all the while collecting a six to nine per cent dividend on my original price. I’m OK with that!

It’s not all upside

What about the blemishes? My most notable is General Electric. I purchased GE in 2006 at $33.30 and in 2008 at $30.92. GE was a star in the 80s and 90s, but since hitting $57 in 2000 it has been a train wreck, currently valued at $9. Dividends made up some of the losses. How does one of the largest and most successful companies on the planet plummet to such depths? Size doesn’t prevent bad management, as periodically good companies go bad.

It is important to put poor outcomes in perspective, staying focused on overall portfolio performance. A good investment can return 10 times in a decade or two, whereas a poor choice can only ever cost you once.

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My first decade of stock investing was unsuccessful so when I transferred my RRSP into a stock account in 1993, I began a new approach. I’ll share examples from this approach, both good and bad.

My longest holding is Bank of Nova Scotia (BNS), held since early 1993 valued at $5.59 per share. Its dividend was 5.0 per cent at the time. Over the 26 years I have received about $39 per share in dividends, almost seven times my original investment. I added to the position in 2016 at $55.33. BNS is currently worth $73.09, and yielding 4.8 per cent.

I purchased shares in three other companies at the same time: Noranda, London Life, and BCE Inc. I added to the Noranda position in 1995 and 1997. Noranda spun off stakes in two smaller companies and merged with Falconbridge, with the combined company being acquired by Xstrata in 2006. I sold at this time, parlaying about $7,000 into $37,000, also collecting dividends for 13 years.

I purchased London Life for $10.06 and sold in 1997 for $34.00, when they were acquired by Power Financial. BCE was purchased at $41.87 and sold in 2000 for $168.05. BCE owned a large stake in Nortel, which was exploding upwards during the tech speculation of the late 1990’s. While my M.O. is to buy value and rarely sell, that doesn’t mean “never” sell. Nortel carried BCE to a ridiculous valuation so I sold. It subsequently spun off Nortel, separating itself from the debacle to come.

I repurchased BCE in 2001 for $34.69, yielding 3.5 per cent at the time and paying out $32 per share of dividends to date. I added to the position in 2013 at $42.62 and in 2017 at $60.68. They are currently $58.92 with 5.4% yield. I have held BCE for all but one of those 26 years.

I purchased shares in three other companies almost 20 years ago, including Power Corp bought for $12.75 in 1999, yielding 1.9 per cent. The dividend has increased to the current rate of 5.4 per cent, paying me a total of $19 per share or 1.5 times my original investment. I added to the position in 2015 at $29.05. They are currently $29.50.

I added Royal Bank in 2000 at $16.01 per share, yielding 3.6 per cent and have collected over $38.50 in dividends to-date, almost two and a half times my purchase price. I added it to my wife’s RRSP in 2004 at $30.51 and in 2008 during the financial crisis, at $35.25. It is now $103.54, yielding 3.9 per cent.

To round out the long-term success examples, I added TransCanada Corp in 2000 at $10.95, yielding 7.3 per cent. I have collected over $30.00 per share of dividends, almost three times my original investment. I added to my position in 2011 at $37.17 and in 2015 at $41.84. It is currently $60.20, yield­ing 5.0 per cent.

Stock investing isn’t possible without a few blemishes. I purchased Barrick Gold in 1999 and Placer Dome in 2001. Barrick bought Placer in 2006, making my average cost $19.15. I sold part of the stake in 2017 for a measly $20.83 and still own part, currently valued at $17.43. It has paid a small dividend adding up to about $6. In 1999 gold was about $400 per ounce and today it is $1,300. I hit the bottom of the gold market when I bought these companies, but haven’t made money on them. That’s what bad management can do.

In 2000 I purchased a small technology company called Kasten Chase. It was a highly touted software security company with supposed lucrative government contracts. What’s not to like — tech, government, security? It went broke taking all $1,600 invested, more appropriately speculated. Fortunately, I didn’t speculate in a big way.

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There are three key advantages of the RRSP over the TFSA. First, contributions are tax-deductible the year they are made, creating an immediate tax benefit. Contributions can be made the first two months of the current year and applied back to the previous year, which is why the deadline is usually February 28th or March 1st. Second, there are no dividend withholding taxes on U.S. stocks. Third, and a much less know benefit, is that retirement funds are generally secure from creditors in the case of bankruptcy. There are some caveats around this benefit which vary from province to province, so please check with your accountant. The main caveat is that if a large lump sum payment is made into an RRSP just prior to declaration of bankruptcy, it is unlikely to be protected for obvious reasons.

This third reason is why entrepreneurs should seriously consider an RRSP, especially starting out when finances of a business are less stable. Nobody starts a business with the intent of going broke but it frequently occurs.

Taking the money out

The key disadvantage of the RRSP is that when it’s collapsed, the money withdrawn is taxable. This is why so many have turned negative on the program even though most will be in a lower tax bracket upon retirement than when working. Farmers, who tend to pay themselves poorly while operating their farms but retire wealthy (please avoid throwing tomatoes at me for writing this) when they sell their operations, may be in a higher tax bracket upon retirement. Let me demonstrate, using the “Rule of 72,” how an RRSP could still be beneficial.

Let’s use a 40-year time period, with nine per cent annual returns, a 33.33 per cent marginal tax rate when the contribution is made, and a 50 per cent tax rate upon retirement. The money would double every eight years, leading to five doubles. A $1,000 contribution would compound to $32,000, and applying a 50 per cent tax rate upon withdrawal would leave $16,000 after tax. However, you also get a $333.33 tax refund. Investing this at the same rate of return would yield six per cent after tax, doubling every 12 years or 3.33 times in the 40 years. Therefore the $333.33 refund becomes $3,547, added to $16,000 becomes $19,547.

Simply investing $1,000 outside an RRSP, achieving nine per cent before tax or six percent after-tax would yield $10,640, considerably less than $19,547.

Dividend or capital gains investment income is generally taxed at a lower rate than straight income or interest income. If we used a marginal tax rate on investment income of half the 33.33 per cent for 40 years, the money outside an RRSP would become $18,720. The $1,000 inside an RRSP taxed at 50 per cent upon withdrawal, with a $333.33 tax refund invested outside the RRSP would total $22,240, still considerably more than investing entirely outside an RRSP. Please keep in mind this advantage exists despite the unlikely scenario of paying considerably more tax upon retirement than when working.

In conclusion the advantages of investing inside an RRSP are better with: a longer time horizon, higher rates of return, higher marginal tax rates, lower retirement marginal tax rates, and in the event of bankruptcy.

I hope this article equips you to use the “Rule of 72” to think through scenarios for your own specific circumstances.

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Mark and Susan have no children, and have come to a point in their lives at which they want to turn the substantial equity in their farm and business into retirement income. They would like to continue farming, but spend winters in Arizona.

Mark and Susan approached Don and Erik Forbes, of Forbes Wealth Management Ltd. in Carberry, Manitoba, for a tax-efficient plan to turn their businesses into retirement income. He suggests a process in stages.

First, wind up the machine shop. The business can pay Mark $60,000 a year in dividends. The farm can pay out $20,000 a year and then defer additional income, Don Forbes estimates.

Second, Mark can purchase the plant and equipment of the machine shop company for $200,000. He might need a short-term loan to finance the transaction, but he will get the money back when he liquidates the business.

Third, create a farming partnership with Susan for long-term income splitting.

Fourth, sell one or two quarters of land for cash to help with liquidating the company and to make hefty RRSP contributions to defer taxable income, to build up Tax-Free Savings Accounts, and to make taxable investments when they have hit RRSP and TFSA limits.

The goal of the plan is to hold annual taxable income in a band from 26 to 35 per cent, to avoid having the maximum amount of income deferred until death where the tax rate could be 50 per cent or higher. As well, making the sale in stages is flexible and can be halted or adjusted at any time.

The machine shop can generate as much as $80,000 a year of pre-tax income. The company can issue taxable dividends, or reduce retained earnings or increase the salaries that Mark and Susan draw.

The machine shop can sell its assets at market price to Mark and Susan. The business would report its sale and pay taxes due. What is left over could be distributed to Mark and Susan.

Alternatively, Mark and Susan could form a new farm corporation and then transfer in at market value the equipment and other assets of the machine shop. The farming corporation would take a promissory note as a shareholder loan and/or fixed value preferred shares. The machine shop would be wound up, but Mark and Susan would need enough cash in the business to pay any taxes owing. Creating companies, paying incorporation costs, and doing the books for a couple of more holding companies would add to total costs but would not avoid the final tab of eventual taxation of distributed money at what could be peak rates.

There is another way: create a partnership for the farm with Susan. Each partner would then be eligible for the Qualified Farmland Capital Grains Exemption Credit. That would save about $200,000 in tax. The new partnership would purchase the machine shop’s assets. Income paid out would keep each partner’s income at about $80,000 per year, Erik Forbes suggests.

The exemptions would be two times $1 million plus the allowable exemption of the primary residence and one acre, a $200,000 further exemption. There are other tax postponements and tax eliminations to use for income saved.

“They should consider a provision in their wills for donation of remaining land and/or financial assets to good causes,” Don Forbes says. “That donation would eliminate any final tax burden.”

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The year 1972, for those of us old enough to remember, was a year that will forever be etched in our minds as the most important year in hockey history. It was the year of the famous Summit Series between Canada and the former Soviet Union. With our best players in the NHL not allowed to compete in the Olympics, the Summit Series was organized to determine true hockey supremacy. The dramatic eight-game series was down to the wire when Paul Henderson scored with just 34 seconds remaining in the eighth game.

Seventy-two is also an important investment number that should always be etched in our minds when we think about investment returns. I am perpetually surprised by how few people know the “Rule of 72,” as I have known it since I was a youngster, probably before the 1972 Summit Series. It’s another one of those little secrets, and is just a very simple mathematical formula: 72 divided by the annual rate of return equals the number of years to double your money. I don’t know why it works, but it does, and is a great way to approximate the value of a current investment at some point in the future.

If you go to the bank and buy a $10,000 GIC (Guaranteed Investment Certificate) at two per cent interest, it will take 36 years to double your money (72/2 = 36). In 36 years that certificate will be worth $20,000.

If you buy stocks and achieve 12 per cent annual returns, you will double your money every six years (72/12 = 6). In the same 36-year period you will experience six doubles: $10,000 x2x2x2x2x2x2 = $640,000. Many will argue that 12 per cent annual returns aren’t realistic but I have achieved 11.7 per cent over 25 years in my RRSP and have other accounts ranging from nine to 17 per cent with shorter timeframes. Even more modest nine per cent annual returns will provide an outcome of $160,000 versus $20,000.

Let’s look at another scenario: How much difference will there be between six and eight per cent annual returns, over 36 years? The seemingly small two per cent difference compounds to represent twice the difference in outcome. The money doubles every nine years with eight per cent returns (72/8 = 9), for four doubles in 36 years. With six per cent returns the money doubles every 12 years (72/6 = 12), for three doubles in 36 years. Therefore with eight per cent returns, $10,000 would become $160,000 ($10,000 x2x2x2x2), but with six per cent returns, just $80,000 in the 36-year period.

Equity mutual fund fees range around two per cent, and two per cent could also be comparable to the difference in a tax-advantaged account versus a taxable account. Two per cent mutual fund fees in a taxable account would exacerbate the situation. Go ahead and calculate the difference between eight and four per cent over 36 years.

The “Rule of 72” can also be used to calculate other compounding factors. If inflation averages two per cent what will a $10 item cost in 36 years? If canola yields increase three per cent per year and are 40 bushels today, what will they be in 24 years? If you increase your farm size by 10 per cent per year, how big will it be in 14.4 years?

The compounding effect of the “Rule of 72” is why I am such an advocate of:

• Stocks over lower-return investments, while accepting the volatility of stocks.
• Investing over speculating, as nine to 12 per cent annual returns builds significant wealth over time. Reaching for higher returns on speculations often leads to disappointment.
• The younger you start the better.
• Starting with small amounts, and contributing regularly.
• Managing your own money (while not the answer for everyone), as saving fees can lead to big differences in outcomes.
• Tax-advantaged accounts.

Answers: $20.00, 80 bu. and 4 times the size.

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Eleanor approached Don Forbes of Forbes Wealth Management Ltd. in Carberry, Man., for an assessment of her problem. It breaks down into generations. She can help her grandchildren by contributing to their Registered Education Savings Plans. The limit is $2,500 per year per beneficiary to qualify for the maximum Canada Education Savings Grant of the lesser of $500 or 20 per cent of sums contributed. There is a lifetime contribution limit of $50,000 per beneficiary and the CESG is capped at a maximum of $7,200 per beneficiary

Passing the land on to the sons is more complicated. Unfortunately, Eleanor, who has not actively farmed the land for decades, is not likely to be eligible for the Qualified Farmland Capital Gains Tax Credit of $1 million. She will, instead, be taxed on the current market value of the land when sold in relation to its cost. The flexibility of valuation in farmland tax credit will not be available.

Being an active farmer

The problem is that Eleanor is not a farmer as defined by the Income Tax Act. To qualify for the credit, the owner must have farmed actively for two years before the sale of the land. “Active” farming is defined as farming which makes up at least half of total gross income.

The definition of active farming has some flexibility, for example, just spending most of the crop season working on the farm and seeking to expand the farm will qualify the individual as an active farmer. In other words, it is application of oneself to the farm operation. Not making money for a few years does not automatically deny the qualification.

Eleanor, who has done nothing but lease the 420 acres, is not likely to be considered a farmer under the Income Tax Act. She can, however, continue the status quo. The land will generate $3,000 per month after tax. The land will be included in Eleanor’s estate and any tax due on a deemed capital gain would be paid by the estate after her passing.

Or, she could sell the land to a third party and invest the proceeds. Using $5,000 per acre as an estimated value and given that $320,000 was the price of the land when purchased, she would receive $2,200,000 at sale less cost or $1,880,000 taxed at 25 per cent for a tax bill of $470,000. The remaining $1,730,000 could be invested. If Eleanor obtains a five per cent annual return, she would have $86,500 in annual pre-tax income. That exceeds her present her annual rent of $36,000.

Another option is for Eleanor to transfer the land to the son who would farm it. The Canada Revenue Agency would have the right to reassess the transaction if the current market value is not used for the transfer.

Creating a company or trust

There is another alternative, though it is both complex and dependent on changing federal government tax policy. The farmland could be transferred into a new company with payment by the company in the form of fixed value preferred shares. The tax liability would be deferred until the preferred shares are redeemed. All the value of the land would be in the shares, so the three sons would get common shares at nominal value. The sons would then have all future appreciation of the land conveyed in the common shares.

The net income of the farm rental would be distributed as preferred dividends to Eleanor.

This structure could be a problem. The federal government is revising its approach to small business taxation. The arrangement could create double taxation under some of the tax proposals. Best bet? Wait to see how new tax rules evolve, Don Forbes suggests.

Finally, Eleanor could create a family trust and transfer ownership of the land to the trust. It would be a flexible arrangement which could include grandchildren. There would be legal fees to set up the trust and annual accounting fees on top of personal income tax preparation costs.

Investing the cash

How much money the land would generate if sold will depend on an assumed rate of return. Using a five per cent assumed return before inflation of two per cent, leaving her to net three per cent, the $1,730,000 could allow Eleanor to net $7,866 per month before tax for 27 years to her age 100. On top of that, she would have her present Canada Pension Plan benefit of $540 per month, Old Age Security of $584 per month and a defined benefit pension from prior work of $420 per month. The total, $9,410 per month or $112,930 per year, would exceed the OAS threshold of about $74,000 per year. After 15 per cent tax on the $38,920 exposed to the clawback or $5,840, and 30 per cent tax on the balance, she would have $6,250 per month to spend.

Her potential spending could be enhanced by cutting the term of the assumed annuity to 20 years. In that period, it would generate $116,285 per year.

Provided that Eleanor leaves her house in town out of the land sale — it is not included in our calculations — she would have a source of capital in reserve. For the moment, it is her home and will be for many years. If she is blessed with long life and lives beyond our annuity calculations, she could sell the house at what is likely to be a higher price driven up by inflation.

Eleanor can also open a Tax-Free Savings Account. She has no TFSA now but any income she saves can be sheltered from double taxation to her 2018 limit of $57,500. She has no earned income and is too old for an RRSP, Don Forbes notes. That she could have used the RRSP for tax deferral decades ago is beside the point. “That time is past,” Forbes adds.

“This plan has many alternatives,” Forbes explains. “Eleanor’s problem is to pick the one she thinks preserves her retirement income and provides for her children and grandchildren best. Tax postponement is a good thing, but one has to balance the complexity of arrangements with the result to be achieved.”

A final consideration is how Eleanor will manage her affairs if the farm is sold. She will have substantial cash requiring selection of financial assets. Her preparation for the task is limited. She would do well to find a professional portfolio manager who would select assets, collect dividends and interest, pay bills and taxes if need be, and ensure that the disposition of her land bears the results she wishes. She can hire a portfolio manager for perhaps one per cent of what could be $1.7 million of assets under management. Assuming the manager uses very low cost trading systems, her fees would be a fraction of conventional mutual fund fees. Trades would be done for her needs rather than the collective needs of other mutual fund investors, Forbes adds.

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There is a deal on the table. A neighbouring farmer has a full-time job for Jorg at $30,000 a year. The neighbour would buy 160 of Jorg and Carole’s 480 acres for $250,000 and rent back to 60 acres of pasture for $1 per year. As well, the neighbour would rent the adjacent 160 acres that Jorg owns for $11,200 per year with an option to purchase that quarter for $300,000 in six years when Jorg reaches 65. The neighbour has expressed an interest in buying the whole farm but the offer has so far not gotten much attention from the couple.

Reviewing the case, Don Forbes and Erik Forbes of Forbes Wealth Management Ltd. of Carberry, Man., suggest that the deal could work. Both Jorg and Carole are eligible for the qualified farmland capital gains exemption. If the farmland market value is estimated at $860,000, far more than it actually is, and the book value, $144,000, is deducted, the remaining value, $716,000 will easily be offset by the exemption. If sales of parcels are staggered, it is likely that no income tax will be paid, Don Forbes notes.

The plan

The plan should therefore be to sell 160 acres for the $250,000 offered and use the proceeds to open and fully fund Tax-Free Savings Accounts that have a present limit of $52,000 per person and the invest the balance in a non-registered investment account. Carol and Jorg have abundant RRSP space, but their income would make such investment tax-inefficient.

Next move: rent the remaining 160 cultivated acres for $11,200 a year until retirement at 65. If the neighbours are willing to purchase all of their remaining land for $480,000, that offer ought to be given very serious consideration. If conservatively invested at six per cent before inflation, it would generate $28,800 per year before tax. In this friendly deal, the farm home, which is not part of the contemplated sale, would remain the property of Carole and Jorg.

Jorg has $7,500 in his RRSP. In six years to his age 65 with a six per cent annual return, it will grow to about $10,000. Carole has $45,000 in her RRSP. In the next six years, assuming she retires and converts to a RRIF at her age 63 when Jorg is 65, it would have an approximate value of $56,000. She can start taking RRIF payments of $2,000 a year with no tax. When she is 67, she can raise her RRIF payments to $4,000 a year. The extra $2,000 RRIF credit can be transferred to Jorg’s return. The $2,000 and then $4,000 RRIF payments will last into the couple’s 90s, though the sums to be paid will be very little after about 20 years, Erik Forbes estimates.

When both partners have reached 65, they can have retirement income of as much as $28,800 with $6,240 from the maximum TFSA investments at $52,000 each, two Old Age Security payments of $6,942 each at 2017 rates, and modest payments from CPP accounts of $3,000 per year for Jorg and $4,500 a year for Carole with a two year or 14.4 per cent discount for starting payments two years before she is 65.Their total incomes before tax will be $66,664. They would each pay about $4,500 income tax, with no tax on the TFSA payouts. Their net after-tax income would then be $57,664.

Sticking to the plan

This is a best-case scenario. Jorg and Carole have to work to 65 and 63, respectively. They will have to obtain solid investment returns from all their financial assets. There will be no farm assets transferred to their sons, though the sons might design a work-to-own plan with the neighbour who buys the farm.

The five years interim between the plan and the sale of the farm would have to be documented with a penalty for each party if the deal is abandoned. Moreover, obtaining six per cent a year from financial assets, which would really be about four per cent after inflation, will take careful selection of conservatively chosen stocks that pay dependable dividends of 3.5 to 5.5 per cent with the underlying shares rising at a few per cent a year.

The assets to be chosen, perhaps with the aid of a financial planner, should be large cap shares of major Canadian corporations. “Large cap” companies are those that are well known on the market. It’s essential that they be Canadian so they can make use of the dividend tax credit. At the income level Jorg and Carole will have, the tax credit, which puffs up the bottom line of taxable income, will not expose them to the OAS clawback which begins at about $74,000 each of personal income.

Large cap stocks which fit the bill would include chartered banks that pay dividends in range of 3.5 to 4.2 per cent, major utilities that pay dividends of as much as 4.5 to 5.5 per cent, and telecommunications firms which pay dividends in a range of 4.5 to 5.5 per cent.

The couple could skip stock selection and instead buy an income-focused exchange traded fund with yields in the range they require. These ETFs have management expense ratios of less than 0.5 per cent a year and some even lower. Each ETF has its quirks of stock selection, so the couple could buy a few and avoid the magnifying glass issues of ratios of banks to utilities make each income ETF a little different from the competition.

“This plan will keep the couple in the lifestyle they know with little financial risk,” Forbes explains. “It requires that they keep working until they can take OAS. Jorg has to work to 65 to get his CPP in full and Carole, retiring at 63, will take a cut of 7.2 per cent per year in her CPP. But the sacrifice is small. In any event, CPP and OAS are life annuities and the operative word is “life.”

There are potential variations in the plan, including selling most of the 480 acres to the neighbour and retaining pasture for rental or a few acres for a large garden. Moreover, the sale document could be written to allow a buyout or a partial buy-in to the neighbour’s operation by the sons if, in the next five years, they can accumulate enough money to make it work.

“This is a survival plan for Jorg and Carole,” Erik Forbes explains. “It will work, it has some flexibility, it provides a modest retirement income, and it can allow the sons to buy in if they can get the money. For Jorg and Carole, it is a good deal.”

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Ezra and Lucy should be able to leave the farm to Edward, but before that happens, they should do some tax management. First move: make Lucy an equal partner in the farming operation. Her value for income splitting is greater than her value as a deductible dependent, notes Don Forbes, head of Forbes Wealth Management Ltd. in Carberry, Manitoba. Don, who worked on the plan with Erik Forbes, a principal at the advisory firm, say that if Ezra and Lucy follow the plan to smooth out their individual annual taxable farm income at $30,000 per year for each and take other measures to harvest value from the farming operation, they can retire in comfort.

They can use the money they take out of farm capital for off-farm investment. For example, they can fill up their Tax-Free Savings Accounts and add money to their non-registered savings. This money could serve as a legacy for their daughter.

At the moment, Ezra and Lucy have all their off-farm money invested in low yield guaranteed investment certificates. They could do much better if they were to move their money to dividend paying common stocks, so-called dividend aristocrats that have paid steadily rising distributions of corporate earnings for at least 10 years, notes Erik Forbes.

Getting started

Ezra and Lucy can also start a process of shifting fractions of the farm, say a quarter section at a time, to Edward. The parents would take back zero interest promissory notes. Edward would pay rent on the land to the parents. The note would be a forgiven obligation at the death of the second parent, Don Forbes suggests. The strategy of gradual transfer of farm capital to Edward will hold income tax down to about 26 per cent a year. The alternative is to defer taxes until death. The latter plan would put farm income distributions at risk of being taxed at a 50 per cent rate. Or more.

The risk is that the federal government may reduce the qualified farmland capital gain exemption, currently $1 million for each farm owner. The prudent thing is to make use of it while it exists, Don Forbes says.

The Alternative Minimum Tax can be charged when using a large credit like the farmland capital gains tax exemption. So when making use of the farmlands capital gains credit, the income tax calculation is done before application of the credit. If the capital gains tax payable in a given year exceeds $40,000, it will be necessary to pay additional tax. However, the AMT levied in a high capital gains tax year for which the farmland capital gain is used remains on the books as a credit toward future federal income tax payable. It becomes a way of prepaying tax, Erik Forbes adds.

In Ezra and Lucy’s case, the temporary cost of the AMT causes can be reduced by the slow transfer of just one or two quarters a year — the amount of land depending on gains in declared value. That should keep the capital gain tax owing under $40,000, Don Forbes explains. Liquidating cattle and crop inventories over several years can help to even out the potential tax burden.

RRSP contribution room can be preserved for years in which there is an income spike that pushes up the couple’s tax bracket. In the year of an auction sale, for example, when income rises, there is higher income that can be defended from progressive tax rates by making RRSP contributions. The goal should be to keep individual taxable income below $90,000, Don Forbes says.

RRSP accounts can be maintained to age 65, then converted to Registered Retirement Income Funds to take advantage of the $2,000 per year pension credit. The first $2,000 withdrawn each year per person will be tax-free and after that, RRIF income is taxed at the higher rate as ordinary income.

Tax-Free Savings Accounts can be used to the present maximum of $46,500 each. If both partners make the fullest use, then after 10 years with initial deposits of $46,500 augmented by $5,500 per person growing at three per cent per year after inflation, the balances will be $127,450 per person or $254,900 when Ezra and Lucy are 68 and 66, respectively. If this money continues to grow at three per cent with no further contributions and is paid out for the next 20 years so that the TFSA balances are zero in 2046, the couple would have $16,650 a year of non-taxable income, Erik Forbes estimates.

Further steps

There is more that Ezra and Lucy can do to boost their retirement income. They can invest in the AgriInvest program up to 1.5 per cent of qualifying commodity sales. The matching government grant is fully taxable when withdrawn prior to or at retirement, Don Forbes notes. Increased annual taxable income ultimately extra Canada Pension Plan entitlements, which boost eventual CPP pensions. It also raises the couple’s eligibility for CPP disability entitlements.

Edward, the son who will eventually return to the farm, can have land transferred to him at any price between the book value and current market value, Don Forbes notes. Bella could be given the value of the growing TFSAs if the total retirement income generated is far in excess of what Ezra and Bella need. This could be a very large sum if, for example, the TFSA grows at three per cent for 30 years. For the couple, both maximizing TFSA contributions of $5,500 a year each after making a $46,500 each contributions to fill space in 2016, the combined balance would be $764,800. The money, representing what might notionally be half of the farm’s present value, would go to Bella in lieu of a division of the estate. Just making her designated beneficiary of the TFSAs would be necessary. This is an efficient way of dividing the couples’ estate and far less costly than buying a comparable amount of life insurance late in life, Don Forbes says.

If Ezra and Bella retire when Ezra is 65, they will each have an estimated one-third of maximum Canada Pension Plan benefits of $13,110 at 2016 values or a combined total of $9,440, OAS benefits at 2016 rates of $6,846 (both in force when Bella is 65) of $13,692, tax credits of about $6,000, TFSA income of $16,650, RRIF income of $4,000 and continuing farm income of $30,000 each. That is a minimum of $109,782 annually. If taxed at an average rate of 25 per cent, they would have almost $6,900 a month to spend. That would more than exceed their present $3,600 a month expenses.

“We can solve most of the problems Ezra and Lucy have in dealing with the transition of their farm provided the couple adopts our plan and follows it,” Don Forbes says. “If they follow the plan, it will work for everyone, ensuring a smooth transition of ownership to the son and a good inheritance for the daughter.”

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