In Vancouver, a couple we’ll call Larry, 42, and his wife Maureen, 49, are looking down the road to a new life when they quit their work in the province’s health-care system, leave Vancouver and set up a hobby farm. They plan to make the transition when Larry is 60, though Maureen, who has some health issues, plans to quit work when she is 57. It will be a major transition from their careers.
They are well on their way to realizing their goal. Their net worth, $595,400 and a generous defined benefit pension plan they expect to receive, will be the foundation for a farm that will not necessarily pay its own way. But getting from their after-tax income of $7,200 per month to their idyll of fruit trees and fawns will require careful planning. Not just to estimate retirement income, but to ensure that the farm will not become a costly albatross that will reduce their standard of living.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple to assess the feasibility of their plans. “Hobby farms can be expensive to operate. On the other hand, their current expenses are potentially quite modest. They have no kids to educate, they should have indexed defined benefit pensions, and they are disciplined savers.”
Debt management
Larry and Maureen should get rid of their debts. They owe $100,000 on their 5% mortgage and $45,000 on an investment loan. Interest on the $100,000 — $1,800 per month — is not deductible. A good move would be to use $61,000 from a taxable investment account plus $10,000 from a tax-free savings account to repay $71,000 of the mortgage. That would reduce their amortization from five years to just 20 months. This way, in less than two years, they will be able to liberate payments of $21,600 per year and divert the money to other uses such as travel or even saving for the farm. The remaining debt is tax deductible and can be left in place, Mr. Moran says.
The hobby farm
The Income Tax Act is not kind to hobby farmers. They are defined as people who farm as a personal pursuit rather than as a business. If the farm is not expected to make money, the farmers cannot deduct any losses from other income. As long as there is an apparent intent to make money, losses can be carried forward, but there is an annual limit of $8,750 of losses that can be applied to other income in a single year. The farm could be purchased with money obtained from selling their present $500,000 home, the mortgage on which will have been paid off.
It would be a good idea to adjust the hobby concept to something that will create taxable income for the farm. That could be selling organic eggs from free range chickens or anything else that creates either repeatable revenue via sales to stores or large profits on occasional sales of unusual critters such as miniature horses for pets.
Retirement
Both Larry and Maureen have fully funded government pensions that are likely to be substantially indexed to the Consumer Price Index.
If Larry works to age 60, he will receive $34,176 per year plus a bridge payable from age 60 to 65 of $9,660 per year. If Maureen works to age 57, she will get $13,200 per year plus a bridge payable to age 65 of $4,800 per year. But her bridge will be used up by the time Larry retires. All figures are in 2010 dollars.
If Larry works to age 60, he will have earned 84.4% of maximum Canada Pension Plan benefits, currently $11,210 per year. If Maureen works to age 67, she will have earned 51% of benefits or $5,715 per year. They can defer taking their CPP benefits until each is 65, Mr. Moran says.
At age 65, Larry will qualify for full Old Age Security, currently $6,259 per year. Maureen will have 34 years of residence in Canada and will therefore receive $5,320 per year, which is 85% of the maximum OAS.
Larry’s RRSP holds $62,000 and Maureen’s $43,000. If they add $3,000 annually to Larry’s for 18 years and $2,000 annually to Maureen’s for seven years, then, assuming a 3% return over 2% inflation, his RRSP will climb to $177,500 by his age 60. Hers will become $72,260. Larry will still be working during the first 11 years of Maureen’s retirement, so her RRSP can be left to compound. She will not need to take money out until Larry retires a decade later. So, if the money is left to grow at the same 3% real rate of return, it would become $97,100 by Larry’s age 60, the planner estimates.
By the time Larry is 60, he will have $177,500 in his account and Maureen will have $97,100 — a total of $274,600. If this amount were withdrawn over 30 years until Larry’s age 90, it would yield $14,000 per year, Mr. Moran says.
The couple’s tax-free savings accounts, which they fund from non-registered savings once a year, currently total $20,400. If each adds $5,000 every year and if the money grows at the same 3% real rate, it will turn into $268,875 by the time Larry is 60. If this were paid out over 30 years, it could produce $13,718 per year in 2010 dollars.
Adding up the various income streams, Mr. Moran estimates that the couple will have retirement income that varies from approximately $90,000 from Larry’s age 60 to 65 to $86,600 after his age 65 as bridges expire and CPP and OAS begin. Their core living expenses with no mortgage to pay and reduced miscellaneous spending would be about $4,000 per month or $48,000 per year, he estimates. Assuming that they split pension incomes for tax purposes and that they pay income tax at an average rate of 20%, they will have $72,000 in initial income to cover core expenses before any future hobby farm expenses. The annual costs of raising tiny horses or heritage apples or whatever they wish could be as high as $24,000 before the couple would have to dig into capital.
To make sure that Maureen is always cared for, Larry should elect a 100% survivor option on his pension. He does not need his wife’s pension. Higher survivor benefits cut potential maximum payments, but it is important that Larry make this provision for Maureen, Mr. Moran says. The survivor would lose the deceased partner’s Old Age Security as part of household income, most of the decedent’s Canada Pension Plan income, and any bridge payments to the decedent’s pension. If Maureen outlives Larry, she could lose income of as much as $50,000. Further, she would lose the ability to split income, meaning that more annual gross income would be needed to meet the same net income requirement. That matters a great deal, for farm expenses would continue. Moreover, the survivor might have to hire help to keep the place running.
Financial Post
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