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.

The post The ‘Rule of 72’: Why don’t they teach this in school? appeared first on Grainews.

Their plan: retire as soon as possible, provided they have enough money from their capital, OAS and CPP to make it work. They figure that with their combined financial savings of $10,000 cash, $250,000 in registered retirement income funds (RRIFs) and $55,000 in tax-free savings accounts (TFSAs), plus farmland worth an estimated $2.7 million, $175,000 of equipment and $150,000 of buildings, they could service $260,000 of a land mortgage that costs them $4,500 per month. The mortgage, now 4.5 per cent, should be paid off in five and a half years.

Farm Financial Planner asked Colin Sabourin, a certified financial planner with Harbourfront Wealth Management in Winnipeg, for guidance. He notes there will be problems. He estimates Frank and Helen, with only $55,000 in their TFSAs available for withdrawal, they would have to make additional withdrawals from their RRIFs. In order to net after-tax $30,000 per year, they would have to withdraw $42,000 per year from the RRIFs.

Those RRIFs are currently locked into GICs (guaranteed investment certificates) that pay 4.25 per cent per year. With loans paid off, CPP, OAS and rental income would cover their day-to-day expenses, Sabourin explains.

They could raise more cash by selling equipment, but that would be problematic, he adds; Frank and Helen have depreciated the equipment. Their capital account is down to $25,000. Thus, a sale at $175,000 would lead to taxable income of $150,000.

That income, even if split between Helen and Frank, would lead to an OAS clawback for a year. Their total income would jump to $235,360. If split evenly, they would each have taxable incomes of $117,680. The OAS clawback starts at $90,997 in 2024. Every dollar of taxable income over that point costs an additional 15 cents tax until they have lost all their OAS. That means Frank and Helen would lose $8,000 of OAS.

That would leave them with $100,000 after clawback and taxes. That could go to their TFSAs. Each has $50,000 of room. Their RRIFs could continue growing, tax-deferred, for eventual and possibly negotiable paydown of their remaining loan.

Frank and Helen do not want to sell their farmland. The cash they raise would end their cash crisis and allow for an inheritance for their two adult children.

It’s a strain, but there is that $260,000 debt with five years of payments to maintain. If the couple rents their land at $100 per acre, it could generate $48,600 which, with OAS and CPP, would cover their estimated retirement costs based on $23,260 CPP and OAS plus proceeds of investments in their $315,000 financial assets. As Sabourin notes, tax-efficient management will allow the couple to keep the farm.

“This plan is feasible, based on sale of farmland at $2.7 million or rental at $48,600 per year before tax,” Sabourin says. “There should be enough income to provide breathing room to make land and capital sale decisions without pressure. A few more years of delay would allow more savings to TFSAs.”

Selling some of their unused farm equipment would add investable cash, Sabourin adds. However, if interest rates were to rise a few per cent before debt is eliminated, the plan to postpone the sale would be in jeopardy — “so better sooner than later,” he concludes.

The post Limited income, large hanging debt, retirement plan in jeopardy appeared first on Grainews.

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.

The post The much-maligned RRSP appeared first on Grainews.

Stocks are the second part of this dynamic trio. For simplicity I will target 10.3 per cent annual growth in a well-designed stock portfolio. The stock market has a century-long record of delivering this level of wealth creation. Many will argue that a 100 per cent stock portfolio is too risky, and this level of performance is unachievable. I addressed both those concerns in past columns. It took me a decade to learn success through simplicity as demonstrated by the “Titanium Strength Portfolio.”

Put in $6,000, Take out $192,000

The third part of the dynamic trio, the “Rule of 72,” can be used to calculate how the wealth creation ability of the stock market compounds inside a TFSA, propelling participants towards financial security. For this example, I’ll use 22 as the starting age. There are all kinds of financial needs at this time in life, but there were all kinds of financial needs for my generation as well, like 14 per cent mortgage interest. We’ll use the current $6,000 maximum contribution for the illustration. This may be a stretch for some.

Using the “Rule of 72,” we can calculate approximately what $6,000 compounds to over a 35-year career. How many doubles do we get? Take 72/10.3 per cent annual return = seven years to double your money. Thirty-five years divided by seven equals five doubles. $6,000 x 2x2x2x2x2 = $192,000. Therefore, if a person puts $6,000 in at age 22, they can take $192,000 out at age 57, with 10.3 per cent average annual returns.

For a self-sustaining program, put another $6,000 in at age 23 and take another $192,000 out at age 58. Put another $6,000 in at age 24 and take another $192,000 out at age 59, to continue for however long you contribute, and subsequently live. The TFSA can become your only necessary savings vehicle if managed correctly. I’m also a proponent of other tax-advantaged programs; RRSPs and RESPs, but the TFSA is my first priority.

Is $192,000 necessary or can we be less aggressive? First, this level of savings allows for some contingency if returns are lower than targeted. Second, we must always be cognizant of the two huge wealth robbers, inflation and taxes. The TFSA program takes care of taxes but not inflation. We can use the “Rule of 72” to calculate inflation impact on our portfolio. If inflation averages 2.05 per cent for 35 years what will things cost? Simply take 72/2.05 = 35 years. The price of things will double in 35 years. Therefore $192,000 will buy as much pleasure as $96,000 today, which provides a nice standard of living. Inflation is why stocks out-perform bonds so dramatically long-term. A three per cent bond will barely keep up to inflation. Using the “Rule of 72” we can calculate the real, after-inflation return on $6,000 invested at three per cent, with 2.05 per cent inflation. The outcome is about $8,750. Which would you sooner live on in 35 years: $92,000 or $8,750?

Googling “compounding calculators” will unearth numerous calculators to input various contribution amounts, frequency of contributions, returns, and length of period. Most of them are called, “compound interest calculators.” Rest assured they work on any compounding factor, including stock returns.

I used some broad generalizations in this column. It is my hope this example illustrates how to use the “Rule of 72” to make it applicable to your situation.

The post A dynamic investment trio: TFSA, Stocks, the ‘Rule of 72’ appeared first on Grainews.

Edna needs to raise her income. At present she has only $2,090 per month in total from Old Age Security ($590), Canada Pension Plan ($317), Registered Retirement Income Fund ($183) and farm rental cash flow ($1,000).

The land sale would raise $800,000 before taxes. With a $160,000 book value, the capital gain, $640,000, would be exposed in the normal course of things to a 50 per cent inclusion rate. Under normal circumstances, the taxable gain, 50 per cent or $320,000, would generate a tax bill of $100,000 or more.

Edna went to Don Forbes and Erik Forbes of Forbes Wealth Management Ltd. in Carberry, Manitoba for planning and guidance.

The advice

“The first objective is to reduce or eliminate the capital gains tax,” Don Forbes says. The land, though currently rented, is eligible for an offsetting Qualified Farmland Capital Gains Exemption, so the taxable gain would be zero.

That tax benefit triggers the Alternative Minimum Tax, and, as a result, a $22,000 AMT is charged and has to be paid. The $22,000 is a potential credit against future federal tax payable over the following 10 years. However, Edna won’t have much tax to pay for the next decade, so the $22,000 AMT becomes an outright tax, Don Forbes explains. The AMT also triggers a provincial tax of $11,000.

The income surge caused by the land sale puts Edna’s income above the trigger for the Old Age Security recovery tax, which is $74,788 in 2017. As a result of the clawback, Edna would lose all of her OAS for the year in which she declares the capital gain. There are ways to deal with the cost, however.

In Manitoba, the first $200 of charitable donations receives a 25.8 per cent tax credit. Any amount over that limit gets a 46.4 per cent tax credit. A $76,000 charitable donation would eliminate all of Edna’s Alternative Minimum Tax and provincial taxes, Forbes notes. The saving would be $32,789. Charitable donations will not affect the OAS clawback; it will still bite. However, it is just a one-year cost.

Edna’s small Registered Retirement Income Fund will continue to pay out at a rate of $2,000 per year or $167 per month. The amount will be offset by the $2,000 pension credit so it will have no tax. In 10 years, the RRIF, which is growing at six per cent per year with investments in conservative telecom and utility stocks, will be depleted, Erik Forbes estimates.

Edna’s Tax-Free Savings Account has a zero balance. She should max it out every year as contribution space becomes available. In 10 years’ time, the account, with a $57,500 limit for 2018, will gain total additional space of $55,000. If Edna invests in stocks with dividends in a range of three to six per cent, with some capital growth, she can average six per cent before inflation adjustments, resulting in a $175,500 balance in 10 years. That balance can pay $15,250 per year or $1,354 per month for 20 years to Edna’s age 97. After the charitable donations are made and the TFSA is maxed out, there will be $650,000 cash left in the account.

Edna will now have CPP of $317, OAS restored after the one-year capital gains-driven clawback, of $590, RRIF income of $167 per month, and investment income of $2,165 per month, total $3,239 before tax. Much of that would be return of capital and not generate a tax liability, Don Forbes notes. Moreover, Canadian-source income would benefit from preferential tax rates, courtesy of the dividend tax credit. In 10 years, the RRIF $2,000 annual income will be gone, but investment income of $2,165 per month and TFSA income of $1,354 per month, total $4,426 will be her permanent income. At 97, the TFSA income will be gone, but Edna will still have her house, and her CPP, OAS and investment income.

“This is a sound financial plan,” Don Forbes concludes.

The post Farm Financial Planner: Selling the farm for cash to live on appeared first on Grainews.

And now… drum roll please… shown in the table above is a titanium-strong, hurricane-defying, bunker-bomb-surviving prospective TFSA edifice.

If you fell asleep for 10 years and woke up just once a year to reinvest the dividends, but otherwise didn’t touch the portfolio, you will be almost guaranteed to double your money. More likely you will have tripled it (recall the rule of 72).

Portfolio details

This portfolio is 50 per cent Canadian and 50 per cent international, exhibiting much greater international diversification than most Canadian investors’ portfolios. The dividend yield is 4.2 per cent on the Canadian side and a lower 1.9 per cent on the international side. I purposely picked stocks with slightly lower dividend yields on U.S. stocks, as the U.S. government will withhold 15 per cent of the dividends in a TFSA. This makes Berkshire Hathaway (BRK.B) an ideal U.S. company for a TFSA. Warren Buffett’s approach is to assume that his company is better at investing than most people, so his shareholders are better off letting them manage their profits, rather than distribute them. He has the track record to prove he’s right.

In theory, when dividends are not paid to shareholders a company has more money to invest in and grow its business, with profits manifesting as share price appreciation. In practice, that much money jingling around in CEO’s pockets tends to get misspent on overpriced acquisitions or can otherwise be misallocated. One reason I like dividends is because they generally motivate greater corporate fiscal discipline, but I’m not about to argue that point with Warren! I’m actually pretty sure he would agree with me in general, but he’s proven that his company can exhibit superior fiscal discipline.

I put a higher percentage of the portfolio into Royal Bank, as Canadian banks also have an enviable track record of consistent profit growth and as such deserve prominence in any portfolio.

While I mentioned that this would be a great portfolio for up to $57,500, if you are a married couple, you can both contribute for a total of $115,000. I would be very comfortable with these 11 companies for a portfolio of that size. I would also suggest that, rather than rush in all at once, you build the portfolio over time.

There are a few ways you can manage the two accounts. You can have the same portfolio in both accounts, or you can split it up, placing half the stocks in one account and half in the other. Another option that might make management easier, is to put all the Canadian companies in one of the accounts and all the international companies in the other. I think this approach could work well if you look at bottom line results as a combination of both accounts. You will likely experience bigger differences in annual performance, from one portfolio to the other, with this approach. It is best to discuss details of account setup with your financial institution.

Dividend growth

The chart includes a dividend yield and a dividend growth column. There is much more to evaluating a company than the dividend but it provides a good benchmark. I am increasingly watching for dividend growth. This column shows the dividend increase of each company based on what they paid in 2017 vs. 2008. On average, these companies are paying two times the dividend they did 10 years ago. Again, if you fell asleep for the next 10 years there is a very strong likelihood these companies will have once more, on average, doubled their dividend. That makes me pretty happy as a shareholder!

The post Where in the world should we invest? appeared first on Grainews.

But how do we start building a portfolio of stocks? Like any construction project, we need the right building blocks. We want to build a resilient portfolio that will hold together in tough times and power forward in good times. We would like a portfolio that doesn’t need constant attention. After all we have our real job, our families and our farms to take care of. We don’t want to spend an onerous amount of time at this. We just want something straightforward and easy to do. How do we go about it?

The approach I take is similar to constructing a strong building. It starts with a solid foundation, then the best materials for the walls and the roof. After we have all the basics taken care of we can add a few options and decorations, to make the building more attractive and interesting, but the basics come first.

It doesn’t take a lot of money to start. I started my kids investing in stocks in 2010 at the ages of 13 and 16, with the princely sums of $1,953 and $4,933. Most of these funds were earned refereeing hockey and lacrosse. This was a great way to learn responsibility. City kids don’t grow up with as much opportunity for early responsibility as farm kids, and refereeing provided this opportunity, with a nice paycheck as a bonus. When they turned 18, the stocks were transferred as quickly as possible into their own Tax-Free Savings Accounts.

The best way for any new investor to invest smaller amounts with an eye to building significant portfolios over time is with the larger, highest quality companies. One of the most important things when starting out is to gain confidence and knowledge. When someone starts with high-risk stocks and loses, they often give up on the market altogether, and therefore give up the market’s great wealth creation abilities. It is best to start with stocks that have a high probability of success, and watch the dividends roll in. With success comes confidence and the potential to add more adventure — the options and decorations — at a later date.

How should these smaller portfolios be structured? I will make the following suggestions for small portfolios. These suggestions could be applicable for TFSA, RRSP, or a taxable account. As portfolios get larger, I suggest managing them differently in light of differing tax considerations, but to start there is less need for these nuances. (I own shares in all the companies noted and may also have options on them.)

Portfolios from $2,000 to $5,000

For portfolios in the $2,000 to $5,000 range, I recommend:

Canadian Bank: 40 per cent of portfolio. TD, RY and BNS have been my long-term favorites. The large Canadian banks have been very reliable performers, with good dividends.

Telecom: 30 per cent of portfolio. The big three in Canada are BCE, RCI.B (Rogers) and T (TELUS). I own all three in different portfolios.

Electric Utility: 30 per cent of portfolio. My two favourite in Canada are ACO.X (Atco) and FTS (Fortis).

Portfolios from $5,000 to $15,000

For portfolios from $5,000 to $15,000: Add in pipeline, transportation and insurance stocks.

Canadian Bank: 25 per cent.

Telecom: 15 per cent.

Electric Utility: 15 per cent.

Pipeline: 15 per cent of portfolio. The biggest are ENB (Enbridge) and TRP (TransCanada).

Transportation: 15 per cent of portfolio. Canada has two big railroads, CNR and CP. I own CNR and not CP. There’s not much to split the difference.

Insurance Company: 15 per cent of portfolio. The big three in Canada are SLF (Sun Life), MFC (Manu Life) and POW (Power Corp). Again I own all three in different portfolios.

In each case simply pick one company from the selection.

Diversification

In my future instalments I will build in more diversification, including international companies, for larger portfolios. I can’t emphasize enough the ability to start small, building over time.

The annual percentage gains of our youngest son’s portfolio have been: 10.1, 7.1, 5.2, 8.7, 18.5, 11.1, 18.2 and 11.3. Today at 21, his TFSA is $30,000, almost double the invested capital.

We paid for the essential parts of his education, so has been able to save a lot of his summer earnings. Our eldest, at 24, has a TFSA worth $70,000.

Here’s another secret: Shh! Investing in stocks is not a rich person’s game, and if done correctly will help anyone build financial security. It’s a good time to start as many of the companies listed can be purchased below previous valuations. I like 20 per cent off sales!

The post How do we start building, secretively? appeared first on Grainews.

The simplicity and flexibility of the TFSA makes it my personal favourite. In future articles I will discuss the other programs but in this, my first Grainews article, I’ll focus on the TFSA and why any entrepreneur, farmers included, might consider having one.

An introduction

First, about me. I am a life-long agriculturalist and remain active in the industry. While building my career I became an active investor in both stocks and real estate. Real estate entails a lot of work, which is difficult when travelling extensively, so I gravitated towards the simplicity of stocks. I sure don’t miss the tenant and toilet days!

I recently penned a book, Stocks for Fun and Profit: Adventures of an Amateur Investor in an effort to help other like-minded amateur investors succeed at stock investing. While I don’t have a formal education in finance, I have graduated from the ultimate educational institution, The School of Hard Knocks! I hope to help others graduate from this school, with a lot fewer knocks than I experienced.

My first decade of stock investing was relatively unsuccessful. This prompted adoption of a different approach. Many give up on stock investing after a few bad experiences, yet the market has driven about 10 per cent annual returns for the last century, and similar returns are likely in the next century. I was not willing to give up on the markets’ great wealth creation ability. Over the past 25 years, I have earned an 11.7 per cent annual return in my RRSP. Other family accounts have long-term annual returns ranging from 9.3 to 17.4 per cent. And here’s the first little secret: rocket science was not used to derive these results.

The compounding effect of such returns is phenomenal. Twelve per cent annual returns doubles the money every six years. I share these personal results strictly for the purpose of illustrating what a straightforward approach can achieve. I refer to it as “success through simplicity.”

TFSA facts

The current maximum annual TFSA contribution limit is $5,500 per year per person over 18. The total maximum limit is $57,500, if you were 18 in 2009 and have not yet contributed. If you can pinch yourself $5,500 per year (just $15.07/day) and contribute for 10 years, achieving market returns, you will build almost a $100,000 kitty, away from the farm. Why would any entrepreneur, business owner, farmer consider a TFSA? Here are a few possible reasons:

• All returns are earned tax-free (Yippee).
• Funds in a TFSA can be used for whatever personal choices you make, away from the farm business.
• It’s easy for a farm, like individuals, to find expenses. A structured plan to set aside a small amount of money each week or month helps a farm and farmer, live within their means. It is a good idea to live below the standard of living you can afford.
• Small businesses, like farms, don’t always turn out as planned. An investment cushion can give you peace of mind that you have the means to move on if necessary.
• If you really, really have to, in an emergency, you can withdraw all the funds from a TFSA tax-free, to support the business. When the calendar turns to a new year, you can re-deposit all those funds, plus whatever new contribution room is available. It’s a very flexible program.

My purpose isn’t to fully explain all the details of the relatively simple TFSA program. My purpose is to try to motivate savings and a straightforward investment approach to help readers capitalize on the tremendous wealth creation potential of the stock market. It is a terribly misunderstood entity and we’ll get into de-mystifying it in the next installment. But for now, I have a secret for you. Don’t tell anybody else, but it’s all about buying common shares in solid companies, and holding them for a long time. Many people in the market aren’t really investors at all. They are traders or speculators. If the market is approached with true investor intentions, effort is reduced while success is enhanced.

The post Shh… don’t tell anybody. It’s our secret appeared first on Grainews.

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.”

The post Farm Financial Planner: Income issues block couple’s retirement appeared first on Grainews.

The main operating entity is the partnership that does the actual farming of grains and oilseeds. It owns the farm machinery, a herd of 200 cattle and 1,440 acres of farm land. The herd uses marginal land for pasture and hay. The brothers personally own another 480 acres each in their personal names. The partnership also rents another 1,600 acres.

The farm partnership has been profitable. It produces net partnership income of $150,000 to $250,000 per year. There are other investments and a revenue property which generates $8,000 a year net for the brothers. Martha has a full time off farm job which pays her $54,000 per year.

• More Farm Financial Planner: Tax planning critical for farm widow
• More Farm Financial Planner: Switching up a succession plan

Erik Forbes and Don Forbes of Forbes Wealth Management Ltd. in Carberry, Manitoba, worked with the couple to plan the generational transition.

The next generation wants to be involved. Herb and Martha have a son, age 27, who works on the farm and would like to have an equity interest in the entire operation. The have two daughters, ages 25 and 21, who have careers of their own and who are not interested in farming.

Herb and Martha want to retire in perhaps 11 years. They would like Larry to inherit the farm and, as well, they want to be fair to their daughters. But securing the interests of the son and the daughters will be complex.

Making the plan

The gain in the value of personally owned farm land will be offset by the $1 million Personally Owned Farm Land Capital Gains exemption for which Herb and Martha are each eligible. They can also exclude the capital gain on their primary residence with one acre. That’s another $200,000. So the first $2.2 million of capital gains on personally owned and farmed land will be tax-free, Don Forbes explains.

However, any gain in the value of the farm partnership will be taxable. Land owned by the farm partnership would also be eligible for the Qualified Farmland Capital Gain Tax Credit as personally owned land.

Farming parents can transfer land any price between book value and today’s market value. This includes any land, equipment, and inventory. The concept is to use up all tax credits and tax exemptions while not also claiming the entire value of the farm and having to pay tax on it on the date of transfer.

There are strategic choices to be made. A major consideration is which assets Larry should have. The package of assets would have a transfer price of the current book value plus the $2.2 million capital gain exemption. Any remaining taxable gain balance would be deferred to Larry through a lower conceptual “purchase price” which would be, in effect, a tax-free transfer of farming assets.

Herb and Martha can take back a zero interest promissory note on the land so that if Larry had marital difficulties or went bankrupt, the land would remain in the family. Credits or an estranged spouse could pursue Larry for the value of the assets, but he would have to pay the parents before their claims would be considered, Don Forbes suggests.

The corporation

The farming corporation is more complicated. If it is a family farming corporation, so favourable farming transfer rules can be used. The alternative is to have it considered as an investment holding company. Normal business estate rules would apply to an investment holding company so that on the death of the owner, all assets are valued at current market value and appropriate taxes paid.

It would be possible to create a separate holding company to own all non-farming assets while the family farming corporation would continue to own only the farm partnership interest. Larry would be the ultimate owner of the farm partnership. For an intermediate way to provide for the daughters’ interests, Herb and Martha could buy a life insurance policy. A policy on Herb’s life for a 10-year term for $2 million death benefit would be $5,300 per year. A similar policy for Martha’s life would be $2,800 per year.

Term insurance is a good solution if it is couple with an investment plan for $40,000 to $50,000 a year. By the tenth year, the accumulated value of the investment portfolio would be sufficient to allow the term coverage to be discontinued, Erik Forbes says. There are two ways to produce retirement income from assets Herb and Martha have built.

First, use the present farming corporation as a profitable business and pay a management fee to the existing personal company. This works, but it is not the easiest path to generational transfer.

Second, have Herb take a salary of $100,000 a year and $8,000 rental income. Put $24,000 into RRSPs to reduce taxable income from the 43 per cent range to the 33 per cent range. This plan, when accumulated money is paid out on the basis of expending all capital and income would generate $4,000 per month for 25 years to Herb’s age 90, Don Forbes estimates.

Martha can use the same mechanism to generate retirement income. By adding a $44,000 bonus from the farming corporation to her $54,000 salary with $8,000 contributed to RRSPs and reduction of taxable income to the 33 per cent range, she would put $4,000 into her RRSP for 11 years and wind up with $900 per month beginning in 11 years to her age 100.

There are other ways for Herb and Martha to reduce taxes. Tax-Free Savings Accounts eliminate the problem of recurrent taxation, first on earnings and then on proceeds of savings in the form of taxable dividends, interest or profits. The maximum is now $52,000.

Eleven years from now, Herb and Martha can look forward to a six-figure retirement income and solid arrangements for transfer of their wealth to their children. Herb’s present income, which consists of $100,000 from the farming business and $8,000 in rental income, and Martha’s present income of $54,000 salary income plus $13,000 in dividends from the farming business, total $67,000, will become $87,000 salary from the farm corporation, $19,000 in dividends, $8,000 in rental income and $24,000 to RRSPs as a deduction. Herb’s final income would then be $90,000. Martha’s restructured income would be $$54,000 in off-farm job income, $40,000 in farm income and bonuses less $4,000 RRSP contributions for final income of $90,000. Total family income would be $180,000 a year after tax-advantaged contributions to RRSPs.

In retirement, each can expect the addition of Old Age Security beginning at age 65 of $6,942, earned CPP benefits of $10,560 a year for Herb and $7,800 for Martha, Registered Retirement Income Fund proceeds of $48,000 a year for Herb and $6,000 a year for Martha, and a work pension for Martha of $13,560 a year.

Total retirement income from all sources would be $279,804 for the couple. The farm interest would be transferred, Larry would have a farm business to manage, the daughters’ interests would be secured, and Herb and Martha would have a substantial income for investment, travel, or donation to good causes, Don Forbes concludes.

The post Farm Financial Planner: Planning a less taxing retirement appeared first on Grainews.