A fair and effective agricultural financial plan for all

A grain farmer we’ll call Owen, 63, farms 1,000 acres of grain not far from the Manitoba-US border. He has three children aged 35, 34 and 29. The eldest, Jack, wants to take over the farm. His two siblings, whom we’ll call Max and John, have jobs in town and don’t want to farm.

Owen’s dilemma is how to transition from farm to Jack, get a $50,000 a year income when he’s 65, and provide living income or compensation to the two kids who don’t want to farm. The problem is both a matter of fate, that is, ensuring the continuity of operations by Jack’s management, and providing a fair settlement for Max and John.

Owen enlisted the help of Colin Sabourin, a certified financial planner with Harbourfront Wealth Management in Winnipeg, Manitoba, to arrange the transfer of the farm.

We need to look at the basic finances of Owen’s farm. The farming company has $6.5 million in current assets, $1,013,000 in current liabilities and a net worth of $5,487,000. There are also non-farm assets, including a $450,000 house, Owen’s $245,000 Registered Retirement Savings Plan (RRSP), and his $90 Tax-Free Savings Account (TFSA). $000. Non-farm assets total $785,000. The total net worth is $6,272,000.

The best move — to do an estate freeze at age 65, then buy back $60,000 of farm society preferred stock for the rest of Owen’s life, Sabourin suggests.

The company is worth $5,487,000. Assuming it grows at 5% per year, it will be worth $6,049,420 in two years when Owen is ready to retire, Sabourin notes. He can then issue new common shares to his farmer son. Any future growth of the company will be in the hands of his son.

In the first year of retirement, Owen was able to redeem $60,000 of preferred stock and do so annually, allowing funds to be withdrawn from the company by 2% per year to regulate inflation.

This process should generate an annual income of $60,000, and there is $6,000 from Canada Pension Plan and $7,380 from Old Age Security (OAS).

On an after-tax basis, this cash flow would generate $58,768 per year. There would be a shortfall of $1,232, which Owen can cover from his RRSP or TFSA, Sabourin explains.

OAS clawback could be a problem as it is triggered when net income reaches over $79,845. The redemption of preferred shares is considered dividend income, so there would be a loss of a few thousand dollars to the clawback provision. This process will leave Owen with sufficient retirement income at age 90.

The estate freeze will allow Jack to avoid having to shell out money for the buyout. Owen will continue to control his agricultural company. If eldest son Jack isn’t running the farm well, Owen can step back and regain control, Sabourin warns.

Two years from now, in 2023, farm assets before adjusting for inflation would be $5,487,000. Assuming Jack withdraws $60,000 from the farm in the first year of the transition and assuming 2% inflation going forward, the preferred stock would then generate a lifetime payout to age 90 of $1,960,254. At age 90, the farm would have an undistributed value of $4,089,163, Sabourin estimates.

Add in $250,000 of personal investments and the $450,000 farmhouse, Owen’s total lifetime net worth would be $5,089,163. A million dollar life insurance policy purchased by Owen ten years ago will fund an inheritance of $500,000 for each of the non-farming children. They will have to sell all the preferred stock they hold to the agricultural society, Sabourin explains. The child farmer will have to purchase these shares with the $1 million life insurance policy that is paid to the farming corporation tax-free. This money will allow the child farmer to buy the shares of his brothers and sisters at $500,000 each.

With all of this done, the non-farmer children will have received $1 million each, while the farmer child will have inherited the $3,089,163 in preferred stock.

Is it fair and equitable? The farming kid will get $3 million worth of preferred stock while the two brothers only get $1 million each. But the farming kid will have to sweat his income, getting up to feed the animals every morning and run the farm, while the non-farming siblings receive $1 million each in passive inheritance. $1 million per child at an expected rate of return of five percent per year will provide them with $50,000 per year each for life. All in all, it’s just an effective plan, Sabourin concludes.

This plan sounds complex, but it’s really just a split of life insurance payments, tax-free, to allow the farm to continue and provide a way to reorganize the share capital of the farm. It is open, fully compliant with tax laws and not difficult to administer once the plan is in place. Above all, it allows Owen to treat his three sons fairly, with the farm going to Jack and a fair amount of money to his two non-farming brothers.