How to Create a Retirement Plan and Leave a Legacy for Your Children
This article was originally published in Grainews. Grainews is an agricultural based publication written for farmers, and often by farmers, in a style they understand. Don and Erik work closely with author Andrew Allentuck, providing the background financial plans and theoretical analysis for Andrew’s Farm Financial Planner column.
In central Manitoba, a couple we’ll call Jack, 57, and Susie, 54, have found themselves in a crisis. The couple left active farming and now rent their land to a neighbor. Sixteen years ago, jack got a city job and sold 480 acres of the farm, half its original 960 acres, to pay debts and to provide cash to buy a house in town. Their concerns now are retirement income and inheritances for their four adult children.
The land retained and the farmhouse they now rent out generate a $20,000 annual pre-tax income. Jack and Susie want to create a retirement plan based on retaining 480 acres as a legacy for their children.
Farm Financial Planner asked us at Forbes Wealth Management Inc., to work with Jack and Susie. Their own retirement finances are predictable. Jack now works for a municipal government. In the usual course of life, an employee with 40 to 45 years of service could expect that his or her to package of pensions; Canada Pension Plan (CPP), and Old Age Security (OAS) income, would be about 70% of a regular salary at age 65. For now, Jack can expect a $953 per month employment pension at age 65.
In Jack and Susie’s case, with a late start to the municipal defined benefit pension plan, Jack will have to catch up. Jack can do that by matching the town’s contribution to his plan, $12,000 per year, allocating 25% of net farm rental income to his Registered Retirement Savings Plan (RRSP), and the same amount to Susie’s RRSP. That works out to $5,000 each, per year. It is consistent with how they are currently saving.
Jack and Susie are saving a quarter of his yearly income of $57,000 salary and $10,000 farm rent. Susie saves about $5,000 per year of her annual $34,000 salary. Tax management has to be part of the couple’s retirement plan. Better now than later.
We advised that “It is better to pay modest amounts of income tax each year in a range of 26%-33% of taxable income rather than to defer the maximum amount of tax until death, where the estate might have to pay tax at a rate of 50% or more.”
The couple’s largest capital asset will be their personally owned farmland. Gains will be offset by the $1 million personally owned farmland capital gains exemption. Both Jack and Susie are eligible meaning that’s $2 million in total. In addition, gains in the value of their farmhouse and one acre – a total estimated value of $550,000 – are exempted. The total of $2.55 million will be tax-exempt.
Leaving a Legacy
The value of the farm to be transferred to the children. The value can be anything between historic book value and today’s market value. If transferred at book value, capital gains accruing to parents might be low. However, potential future gains to children may be high. In the opposite case, if transferred at market value, capital gains over the exempted sums may be high and taxable to the parents. However, the value base for children when they take and future gains for sale will be less.
The plan should use up all eligible tax credits and tax exemptions without claiming the entire market value of the farm. This will allow the parents to not pay tax as of the day of transfer.
The next question is, which children get what. Roughly $960,000 of value will be entirely offset by the farmland capital gains exemption. The land itself can have a value of $2,000 per acre, which they can retain in full by qualifying for the farmland capital gains credit.
However, in the year of realization of gains, before the offset, all of their individual OAS benefits that start at 65 would be clawed back and the alternative minimum tax (AMT) would be imposed. The AMT itself would be recoverable in years after it is paid as a credit on future income due in the following 7 years. It is important that this is done in years before a final return is filed.
The transfer of land and related assets could be done in the near future to the eldest son, Peter. Peter lives next door to Jack and Susie’s farm. The remaining three quarters can be transferred to the other three children. That provides a roughly equal division of assets. Any shortfall could be made up of money from investment accounts.
To protect the family’s assets to be transferred, it would be wise for Jack and Susie to take a 0% interest promissory note on the land. This protects the parents’ future retirement income in the event that and child were to get into financial difficulties through divorce or bankruptcy.
Were that to happen, creditors or an estranged spouse could seek the value of the assets. However, they would have to pay the parents first before claims could be considered. This way you give the title of the land to the children but you maintain control of it if you are relying on it for part of your retirement income.
In The End
When both Jack and Susie are 65, they will have two OAS pensions at $7,362 per year each. That works out to $1,227 per month combined. Their CPP benefits will have a combined value of $1,846 per month. Jack and Susie’s work pensions will total $1,085 per month. Their RRSP/RIF income will total $1,800 per month.
Jack and Susie can add land rent if they have not sold the remaining acreage. That would add $1,660 per month to income. Investment income would be $200 for non-registered assets. We are not including TFSA income. We will regard it as an emergency fund. The total value of all income streams would be $7, 818. Assuming that they pay an average combined $1,200 per month for income tax, they would have $6,618 per month to spend plus any money taken from their TFSAs. The $6,618 is more than their $5,000 target after-tax retirement income with inheritances planned and taxes average at relatively low rates for many years.
This plan allows for TFSAs to be established and to absorb income over the estimated amounts. If Jack and Susie add $4,000 per year combined to TFSAs starting when Jack is 65 and if the assets grow at a nominal rate of 2% just to keep up with inflation when Jack is 70, the TFSA would be worth $20,800. At age 75 it would be worth $43,800. Then At age 80, it would be worth $69,200.
At age 90, the TFSAs combined would have grown with surplus income and our estimated modest 2% annual return to $128,100. TFSA capital growth and income would not be taxed on a final return. TFSA cash flow would compensate for the loss of splitting eligible income at the death of the first partner and loss of his or her OAS and CPP and job pensions without survivor benefits.
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