After many years of farming, good and bad, Bill Ashworth had reached the point in his life when he was ready to retire. After farming for 45 years, Bill and his wife Wilma had decided the physical demands and the emotional rollercoaster of farming was simply taking a toll that they could no longer accept. The Ashworth children had left the family farm and established careers of their own out of province in cities offering a lifestyle much different than rural Canada.
Like most retiring farmers, Bill and Wilma did not require high cash requirements during retirement. After all, during their farming years any available cash was always needed to purchase land or upgrade equipment. They had learned to live within their means being asset rich and cash poor. Bill and Wilma wanted to retain their farm land for their children just in case one of them should decide to farm in the future. They had decided to have an auction sale to dispose of farm equipment. Grain and cattle inventories would be liquidated after their last harvest. Bill and Wilma were expecting a substantial income tax bill as the auctioneer and coffee row had prepared them.
Let us take a closer look at the Ashworth family farm, as shown in the following chart.
To minimize income tax, Bill was considering disposing of his cattle and grain in the current year and having the auction of his farm equipment in the following year. This strategy would result in income tax of $351,932 over the two years leaving cash of $448,068 to fund retirement.
The big question always asked by retiring farmers is how income tax can be reduced and whether they can afford to retire while retaining part or the entire farm for their children.
Although the farm land can be transferred to Bill and Wilma’s children during their lifetime or upon their death without incurring income tax, it’s suggested that the farm land is retained by parents to generate rental income to support retirement needs. Although farm income has always been reported in Bill’s name only, as it is owned jointly with Wilma, rental income could be split equally between Bill and Wilma to reduce income tax.
Having discussed tax strategies with Bill and Wilma, it was decided to establish a farm corporation in which to liquidate the cattle, grain, and equipment over the same two year period. The use of a farm corporation reduced Bill’s income tax from $351,932 to $100,000 payable by the company resulting in a tax deferral of $251,932 and after-tax proceeds of $700,000.
As the proceeds of $700,000 held in the corporation is required to fund Bill and Wilma’s retirement, the cash must be withdrawn from the corporation. Simply withdrawing the retirement fund out of the corporation in a lump sum or over a number of years would have resulted in personal tax of approximately the same amount of tax that was deferred. Having Bill and Wilma draw this retirement fund out of the company as a dividend in equal amounts over 10 years will create total personal tax of $25,000 and an absolute tax savings of $75,000.
A tax deferral of $251,932 in your early 60’s can make a significant improvement to income during your retirement years. Investing this tax deferral in a balanced portfolio assumed to earn 5% annually will increase retirement income by approximately $1,050 each month.
Although there are many other factors that can either enhance the above tax strategy or possibly make the tax savings more difficult to achieve, proper tax planning will normally result in reduced taxation, often identifying other opportunities to minimize income tax.
A comprehensive retirement plan can clearly lay out tax saving opportunities and the foundation for an enjoyable and well-deserved retirement. It often identifies tax savings strategies that can enhance income to allow you to live a retirement for reasons that are important to you. This is one of the services available through our team of specialists at The Retiring Farmer.
Donavon K. Tofin CPA, CA, CFP
The Retiring Farmer™ Wealth Management Process & Assante Financial Management Ltd.
*Don Tofin is a Senior Financial Avisor with Assante Financial Managment Ltd. Please contact him and his team at The Retiring Farmer™ to discuss your particular circumstances prior to acting on the information above.