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Plan before you retire

Whether you’re selling or if you’re transferring farm assets to the next generation, tax-smart retirement takes planning… and time

In 2011, 48 per cent of Canada’s farmers were 55 years old or older. Five years earlier, the number had only been 41 per cent. If you draw a straight line, that means 55 per cent of farmers are now 55 or older. And it also means our median age is approaching 65!

Whether that’s exactly how the statistics will turn out, we won’t know until Ottawa publishes the results of the 2016 ag census next May. But either way, we’re on the cusp of a huge wave of farmers ready to retire.

Already we’ve seen an upward cycle of asset liquidation and consolidation, as farms get bigger and more valuable. Following many years of average farm asset appreciation, in 2015 it was again up 6.2 per cent across Canada. This increase in land values combined with lower commodity prices has put the thought of retirement into many farmers’ heads.

Plus, baby-boomer farmers often want to retire younger and do not want to keep farming until they die. Now they can afford it.

If the children have left the farm, many baby boomers are asking themselves whether they should expand, or whether they should sell.

Is it worth it to keep growing, with all the risk attached? Are you going to be at it long enough to get a payback from scaling up?

Recently, Glenn Dogterom, accountant with MNP in Lethbridge, Alta. has seen a different scene being played out on many western Canadian farms. “When someone knocks on your door waving a cheque for several million dollars, it can be a pretty easy decision to sell and retire,” he says.

Although, the cheques look big enough to retire from farming while your health is solid, the challenge is to not let them get eaten up by the tax dog.

The truth is, most farmers haven’t done any retirement planning. They’ve felt they haven’t had to, because the plan was just to sock everything back into the farm and to avoid taxes by taking small draws throughout their entire careers.

But this can be costly in the end.

“Waiting until the last minute is not effective tax planning,” says Dogterom.

In one example Dogterom worked on, a retiring farmer sold his farm. He had done his own tax filing for 30 years and had not used many personal deductions. It was in a sole proprietorship structure and after the dust settled from the sale, he discovered that he owed $300,000 in income taxes.

With some time and planning, there are ways and tools to help minimize the taxes on the sale of farm assets. “Tax itself isn’t a bad word,” says Dogterom. “We just need to use the rules the government has made available to us.”

By setting up a farm asset distribution plan ahead of retirement and in case of death, you’ll get better use out of the Tax Act’s capital gains exemption and land-rollover provisions. “Investment planning is also part of tax planning, so use the tools available to plan for when you contribute and withdraw,” says Dogterom.

Although there’s no inheritance tax in Canada, procrastinating doesn’t necessarily allow you to take advantage of the rollover provisions or the corporate tax advantages that are available. Besides, leaving all the decisions for the remaining spouse isn’t fair and can cause additional difficulties and stress for the family.

Young generation says, “Go!”

Larry Batte, a chartered accountant with Collins Barrow in Stratford, Ont., is seeing more farmers being pressured by their children to retire sooner — in their early 50s. He’s even seeing gold-digger children trying to push their parents into transferring the farm to them right away.

To ensure everyone is treated fairly, he suggests a predetermined five-step approach that slows down the process first with a transfer of management, followed by ownership.

This way, the younger generation begins basically as labourers and then moves to management as their skills develop. Once proven capable, they can be given a small portion of growth, maybe starting with 10 per cent of the common or growth shares, in addition to their wage. A decade or more later, the final steps kick in and the successors begin to get ownership beyond the growth.

Yet fundamental control on how the company operates overall isn’t transferred for many more years.

Until then, the older generation maintains voting control so the younger generation can have their say but can’t make any huge changes without the parent’s consent. Rarely is this control card played, but it just makes everyone feel more confident knowing it’s there, says Batte.

This process also enables a slower transition into retirement, which in turn allows for tax planning, investing and communication.

It’s important to sit down and explain your vision of how you want your retirement to look to your family and business partners, says Batte. Then, using trustworthy advisers, sort out the best possible options with that goal in mind.

“Get a team in place,” says Batte. “A lawyer, an accountant, a financial adviser, maybe a human resource specialist, and someone to help with the soft issues. Then, as a group correlate your retirement (and succession plans) to your estate plans.”

Value of incorporation

One useful retirement and succession tool is to set up a farm corporation structure while you are still actively farming.

First, it’s a way to deal with the taxes on the future sale of inventory. Small business corporations pay about 14 per cent on the first $500,000 of income in Alberta. Dogterom says it’s often better to go ahead and pay the 14 per cent, and build up tax-paid reserves. Then you won’t have a massive tax bill on the sale of inventory to deal with when you go to sell the land.

For example, if you have a 250-head cow-calf operation, ahead of retirement you could roll the cattle into a farm corporation, keeping the land separate and renting it to the farm corporation. At retirement, if you keep owning the land personally and sell the cows (now in the corporation), the income from the sale of the herd will be at a much smaller tax rate than if you continued to hold them in a sole proprietorship or partnership.

Dogterom says by putting the inventory and equipment into a farm operating corporation ahead of retirement, say, for five years, you’ll pay income tax in advance and will have all the inventory taxes paid up at a much lower rate than if it was taxed at sale time outside of a corporation.

“It comes down to how do you manage the cash that comes out of this sale,” he says.

Time for a holding company

Holding companies, sometimes affectionately known as HoCo’s, could also be a strategic move to reduce total tax burden.

In the past, holding companies have been used only as operating companies for non-farming types of investments. But, says Batte, “holding companies are becoming more and more popular.”

The attraction is the opportunity to transfer money from the operating farm corporation to a HoCo on a tax-free basis. Also, each corporation can pay dividends, wages, make loans to its shareholders, and that can be very handy for succession or for winding down and getting funds out of a farm. For example, you might think about setting up your non-farming children as shareholders of the HoCo so they can receive dividends.

Moreover, HoCos can be set up to keep funds in the operating company “clean” or not over the threshold for government to consider it not a qualified farm or small business income. By transferring funds to a holding company you can purify the farm’s corporation if it has too many passive assets. (To be considered an operating business, the non-farming assets, such as excess cash in the farm company, need to be less than 10 per cent of the value of the assets.) Keeping this status is a way to ensure you can use capital gains exemption and rollover provisions.

Tax-Free Savings Accounts

If you have extra cash flow, tax-free savings accounts (TFSA) are easy to set up at any financial institution and unlike an RRSP, can be withdrawn from without penalty. Although contributions made to a TFSA are not tax-deductible, the withdrawn funds are tax-free, so you won’t get taxed on any income your investments in a TFSA earn, even upon death. “Tax Free Savings Accounts are no brainers,” says Dogterom.

Originally started by Harper’s former government as a way to encourage Canadians to save more, from 2009 until last year the amount we were allowed to put in a TFSA increased steadily. However, starting on January 1, 2016, the annual TFSA dollar limit for 2016 decreased from $10,000 to $5,500. From now on, instead of being accumulative, the TFSA annual room limit will be indexed to inflation and rounded to the nearest $500. If you take it out, that doesn’t count as space.

However, if you contribute more than your allowable TFSA contribution room, you’ll be considered to be over-contributing and will be subject to a tax equal to one per cent of the highest excess TFSA amount in the month, for each month that the excess amount remains in your account.

AgriInvest

Many farmers have been putting aside money for a rainy day using an AgriInvest account. For older farmers this rainy day can mean when they are slowing down, decreasing production or, in other words, retiring. Farmers can invest one per cent of allowable net sales (ANS) each year into this self-directed risk management account and receive a matching government contribution.

Although the limit on matching government contributions is $15,000 a year, you can contribute up to 100 per cent of ANS annually and up to 400 per cent of ANS in total. This is for non-supply managed production only.

“Investing in AgriInvest is a slam dunk,” says Dogterom.

The government-supported part has to be taken out first and it’s the taxable portion. However, farms with large turnovers, like feedlots, have large amounts they can invest and will get larger government contributions.

Unlike the old NISA, with AgriInvest there are no premium bonuses or interest rates being paid. Also, compared to NISA a smaller amount is matched by the government. Many farmers are thinking that their funds are better used to drive profitability on their own operations, says Batte. “AgriInvest is not used as much as NISA for retirement savings,” he says.

Pension plans

Recently some financial companies have come out with professional pension plans for farmers.

There are two different pension plan structures, the Professional Pension Plan and Individual Pension Plan. Both are owned and paid for by your corporation, with the farmer named as plan member. This is a deductible expense for the corporation and provides a tax-efficient way to take money out of the business.

Neither Batte nor Dogterom have had any farm clients interested in PPPs or IPPs. The farm must be incorporated to use a pension plan, and it’s not something that can be set up easily on your own. “They’re fairly sophisticated,” says Dogterom.

An IPP is even more complex as it requires the incorporated person to hire an actuary, an investment manager and funds custodian. Even though the management fees and all other costs associated with the plan are tax-deductible for the incorporated business, it’s still costly. These services and fiduciary oversight are already built in to a PPP.

Like an RRSP, investment into a PPP triggers a tax refund and grows tax-sheltered inside the plan. However, PPP has an advantage over an RRSP because you can put away more money in a shorter period of time, especially over 50 years of age.

For a tax-effective retirement strategy, you can set up a holding company for the pension plan and register it as a Registered Retirement Savings Plan. As many farmers haven’t contributed to RRSPs, they can use up multiple years of available RRSP space. This works really well if you do it the same year farm assets are sold. The pension funds in the holding company can either be managed by a trusted investment company or be self-directed.

RRSP

Registered Retirement Savings Plans (RRSP), are about tax bracket timing and tax deferral. RRSPs are a tax deferral and should be managed around taxable income levels. For many retiring farmers, when they sell assets is when they’ll have a higher income. Then they’ll be paying taxes on the RRSP at the higher tax rate and for that reason, for most farmers, it’s not a useful tool. “I’m not a big fan of RRSPs,” says Batte.

On the plus side, RRSP contributions are tax deductible against your income. The idea is to delay the payment of tax until retirement, when you’re earning less and your tax rate is lower. You can also set up a spousal RRSP and put money into it with the spouse as a benefactor but you get the tax deduction.

If you don’t withdraw, RRSP savings are rolled into a Registered Retirement Income Fund (RRIF) when you’re 71 years old. After that you’re required to withdraw a minimum amount each year based on your age and government regulations. A RRIF is basically the “taking out” account of RRSP.

On the plus side, the initial setup costs are minimal and it’s a well known, common and accepted way to save for retirement. It’s also a forced savings account because you’ll likely not withdraw it until you’re retired.

Canada Pension Plan

Canada Pension Plan is another very safe way to save for retirement, and if your farm is a sole proprietorship or partnership, you’ll likely have contributed based on your earned income. If your farm is in a corporation, dividends, rent, or interest on a shareholders loan can pay you, so you wouldn’t have had to pay into CPP. But if the corporation paid you a wage, you likely have contributed into CPP.

You can also voluntarily pay into the CPP plan. Basically, with this government-controlled and -managed pension program the more you put in, the more you’ll get out. The maximum amount is about $950 per month, but that would require that people contributed the maximum amount to their CPP over the years, which many farmers do not.

Advice around CPP varies. Some accountants suggest paying into CPP at a minimal amount so you get the disability tax credit and CPP in case you get hurt or die.

Dogterom usually advises his 50-year-old-plus-clients to pay into a CPP plan. “It’s a reasonably good plan and all you need to pay yourself is $48,000 or $50,000 a year to maximize it,” he says.

If you’ve paid into CPP since you were 18, Batte says at 55 it maximizes and doesn’t have as a significant return on investment after that point. Most of his clients don’t have to rely on CPP for their retirement. “If you’re counting on CPP, you’ve made some serious mistakes (managing your farm assets) along the way,” says Batte.

Rental Property, etc.

Back in Ontario, Batte says that about half of his retired clients have investments outside of their businesses, and often it’s land rented back to the farm. Instead of drawing cash flow out of the business, they keep money invested in assets that are productive for their businesses.

Only about a quarter of them have off-farm investments, like rental properties in town, mutual funds and equities. However, Batte says his farmer clients between 45 and 55 years old are more likely to look for investments in other places.

The best vehicles and tools for retirement vary for every situation so make sure you consult with your team of advisers, including your accountant. They’ll know the details and history of your situation and should help you not miss any options in your planning.

Sometimes people forget about investments they made years ago. For example, if you’re a member of a co-operative that has been building patronage reserves, says Dogterom, you probably want to cash that fund out when you retire. Don’t forget to apply for the payout for the plan.


Good advice? Be careful

We’ve all heard about con artists, ponzi schemes, pyramids and financial advice gone wrong. Their geographic isolation and large wealth at sale of a farm make retiring farmers a big juicy target for financial fraud and bad advice.

Choosing a financial professional is one of the most important retirement decisions you’ll make. Not only must they be trustworthy and understand your needs, they must be competent with larger-scale funds.

Always check references and ask friends and professionals for recommendations. An online search to check for whether a particular professional has been sanctioned by regulators or industry bodies is another good idea. If advisers promise sky-high returns, if they won’t give clear answers about how they’re paid, or if they provide complex, jargon-filled responses to simple questions, then be very careful.

Any time you’re making big financial changes you might want to consider looking around for other help, comparing fees and scope with your current provider. Other products might work better for you in this new circumstance. It’s your responsibility to understand your portfolio’s performance and strategy.

 

How much is enough?

When chartered accountant Larry Batte meets with his farmer clients to discuss retirement, he gets them to fill out a personal cash-flow lifestyle worksheet. The vast majority of the folks find their estimated living expenses are at least 50 per cent short of the estimated budget needs. They forget that the farm has been paying a portion of the home’s utility and vehicle expenses and often providing some food.

Paul Vaneyk, a financial adviser in Peterborough, Ont., says that a good estimate to use is a four per cent withdrawal rate to figure out how much you’ll need in total nest egg to retain the principal. So if you want $50,000 a year over CPP, using that estimate, you’ll require $1,250,000.

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Senior Business Editor

Maggie Van Camp

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