Rainy Day Fund – How primary producers have new retirement options outside of selling land.
I have learned that having a filter is important in business; I have also learned that in some circumstances, transparency and truth are more important.
I used to hate talking to small acre family farms looking for succession and transition help. After numerous accountants and other professionals had led them along for far too long, I often had to be the one to tell them the truth. The truth is, you need more acres, and you needed them ten years ago when your child was beginning to show interest. At this point, off-farm income is the only way to have a successful transition without risking your hard-earned retirement.
In agriculture, as in other industries, a business needs to be a certain size in order to sustain multiple owners or family members. It is not an exact measurement, but I always like to use 3,000 acres as the breaking point per family unit. There are exceptions, for example if the farm has minimal to no debt obligations and does not run new equipment each year, but these are few and far between these days. The truth is growth is required in order to increase mouths to feed.
So, what does this have to do with retirement? I have recently been approached with some newer ideas in terms of transition. Such as, what if farming was more like a nine to five job when it comes to retirement? What if you made it a priority to have a pension plan in place so that land and business cash-flow was not the only source of income for retiring family members? It has been discussed before, but with new rising costs of production and land values, it has become more of a focus in my discussions these days.
I thought I would touch on this subject from the retirement perspective. Unless you have purposely set up personal investments and accounts throughout your farming career (most family farms made reinvestment into the business the main priority), or the farm has created a treasure chest of cash and working capital to start the retirement process, there are only a few alternatives to a successful transition of a small acre family farm.
Sale of Land
Although I bring this option up, it is not an alternative I will ever use. First of all, the amount of debt required by the next generation to actually purchase the land, plus the possible tax consequences to the retiring parents, makes this a less than ideal circumstance. The problem I have found is that the land is often the only place that the farm has added value throughout its life. Many family farms have come through tough times and there is not a lot of equity outside of land to show for it. That makes this a bad option.
In an environment where the stock market is volatile, and real estate is not always a sure thing, why as a retiring owner would I ever want to sell my land? The value increase on land outranks the current high guaranteed cash rates (by almost double), and it is a hard asset that avoids inflationary adjustments. This reminds me of the long-lasting joke of a farmer who sells his land, then walks into his financial advisor’s office and asks what he should invest in. The advisor looks at him and says, “buy land”.
Stripping Cash
This is often done in terms of paying land rent to the parents, or allowing them to continue to draw earnings out of the farm even if they are not really contributing labour or management (maybe in the form of a return on equity remaining which may not be significant). The reason this is often detrimental is that the farm may not be able to afford additional land rent for transition in these high times of cost of production. I have seen land, building, and finance costs continue to rise over the last couple years where that measure on many farms has eclipsed $100 per acre. In combination with machinery, labour, and crop inputs, many farms are approaching $600 per acre total in costs. If this is the case, it makes this retirement option less and less viable.
The other issue is the tax consequences. Land rent paid, if in a company, is greater than 50% tax in most instances, and may also come at a higher personal tax bracket depending on who owns the land (husband, wife, or both). Not that tax ever “drives the bus” when it comes to operational decision making, but as an accountant I would feel inadequate for not bringing it up.
The New Alternative – Farm Pension Plans
Lately, an interesting option has been presented, that of farm pension plans. I used to assume that all farms wanted growth of acres, but I have been corrected as of late that many family farms want to remain smaller, and more lifestyle related. This is not a detriment, in fact in many ways this is the backbone of agriculture. If this is the case, we need to come up with alternatives for succession and transition that work from a money and business sense. After all, feelings don’t pay the bills.
I have been having more and more discussions on setting up pension plans for ownership. This is a way that allows for the operation to make smaller payments throughout its life so that when the time comes for transition there is no financial drain directly on the entity. With the current ability to use tax free savings accounts and registered retirement savings plans in these alternatives, it also has a bit of tax kick to add to the mix. Overall, this is a solution that allows the parents to have pension funds for retirement rather than having to start drawing cash out of operations which may make transition unaffordable. It is also a way to reduce the need for off-farm income by the next generation so that operations and profit don’t take a hit throughout this process.
For the growing farm, this doesn’t need to be seen as negative. These plans can be set up for employees as well as ownership, so they allow for a great human resource retention or hiring strategy. In today’s labour market, having an edge when it comes to benefits is always a plus for the family farms. In fact, the majority of farms I work with have something in place already, and at HGV we have seen its effectiveness firsthand by showing employees that a long-term career is possible with a retirement in place.
Now I am not saying this is for everybody. In fact, historically, farming has tried to avoid paying into investments when the farm could utilize these funds elsewhere. However, as I mentioned at the start, you need to start planning ahead and growth of acres is not always something everyone is comfortable with. Setting up that rainy day fund can be a strong strategy when it comes to retention; because after all, we know it has to rain in Western Canada sometimes.
If you are interested in more information on agriculture pension plans, reach out to Farm Legacy Retirement Plan through IA Financial at allan.howat@kingsmerefinancial.com.
