Financial

SPRING 2007

Alternative Options

Len Davies–Davies Legacy Planning Group

 

More and more farm families who are contemplating the transfer of the farm to the next generation since the first wave of the baby boomers are now at that point in life that their farming children are actively involved in the farm business. At first it may appear to be a daunting task but it does not have to be. Some of the following alternatives may help you in your thought process. There are however many other options available and you have to choose the option that suits you and your farm situation the most.

So let’s look at some alternative options.

The following scenario is what I have used to develop the options. We have a farm couple Mr. and Mrs. Smith who have one son who wants to farm and 2 daughters who are living in a city, all with careers of their own.

Alternative #1

The son farms with his parents until the last parent passes away. At that point the son buys his sisters out. This scenario has several problems:

• What happens if the parents change their wills and leave it to the girls only?

• Can the son afford to buy out his sisters at that point in time?

• What happens if one of his sisters (or both) want to continue owning the farm?

• What happens if the son loses interest since he has no ownership?

• Is it fair for the son to wait that long to see what the end result will be?

• If he was not on the farm the parents may have had to sell the farm years before their death at a value far below what it would be when he has to buy it from his sisters. If the son had to purchase it then he would be buying out some of his own equity.

Alternative # 2

The Smiths could purchase a last to die life insurance policy on them leaving the son the farm and the two daughters the life insurance benefit at the death of the last surviving spouse.

So let’s look at this scenario:

• Both parents must be healthy to apply for a life insurance policy.

• The premiums maybe too high if the parents are older or the parents qualify but a health issue makes the premiums more expensive.

• Does the son want to wait that long to eventually get ownership of the farm?

• Life insurance premiums are far less expensive than mortgage payments.

• The son feels better knowing a plan is in place for him to become the eventual owner.

Alternative # 3

You could look at an option where the son buys the farm at the death of his father. He may purchase a life insurance policy on the life of his father only. At his father’s death his mother would have the funds to retire on. Any funds not utilized by the mother would be passed on to the two daughters. Under this scenario:

• The son gets ownership earlier if the father dies first.

• Father has to be insurable.

• Premiums could be expensive if father is in advancing years or has a health problem.

• Life insurance premiums are less expensive than mortgage payments.

Alternative #4

Split the farming enterprise in two. One part could have all the farming assets other than the farm land and which would pass to the son at the death of the first person. (may have some of the farmland in it also) And the second part would have just the land in it. There could be a first to die policy to purchase the first portion of the assets to be transferred. The purchase of the remaining assets transferred at the last death would funded by the proceeds of the last to die.

• The main advantage here is to get some of the assets into the son’s hands sooner than waiting for the last death.

• The mother if she is the survivor will get access to some cash to fund her retirement rather than relying from proceeds from the already cash strapped farm.

• A last to die policy is less expensive than a first to die policy. Both in this alternative will be used to fund 100% of the farm transfer.

• One drawback is that the son does not get ownership of the farm land until the last owner dies.

• Assets other than land will no be eligible for capital gains exemption so your tax liability could be higher using this scenario.

Alternative # 5

Incorporate the farm would be an easy way to let the son get ownership of the farm immediately. An incorporated scenario would look like this:

• Son would own minimal shares now and as the farm appreciates in value the increase would go to the son.

• The parents would own preferred shares which would not increase in value and an estate freeze would be in place.

• There are extra costs involved when incorporating.

• You would lose your capital gains exemption if you included your residence in the corporation.

• A last to die life insurance policy could be purchased to fund the purchase of the preferred shares by the corporation from the daughters.This must be backed up with a buy-sell agreement that is triggered at the death of the preferred shareholders.

• Incorporation may not be for everybody since it is difficult to dissolve later if that becomes an issue. One must be aware of the downsides of incorporating before they decide to go that route. Research this option carefully before you decide to incorporate.

There are many other alternatives available to transfer the family farm. You need to develop one that suits your needs, goals and objectives and those of your immediate farm family. We have not even touched on the financial, tax and legal implications of these scenarios. These are the reasons why you need to include all of you farm advisors when drafting up a succession plan for you and your farming enterprise.

WINTER 2007

Trust and Estate Planning

Len Davies– Davies Legacy Planning Group

There are many different types of trusts used to hold and own property. These trusts can be broken down into two different categories. One being an intervivos trusts (trusts established while a person is alive) and testamentary trusts which are trusts that are set-up when the person who wants to transfer property at death dies. This trust is set up through the will of the deceased.

For the purpose of this newsletter we will deal with testamentary trusts only and in particular a trust that deals with a straight transfer from a settlor at death to a beneficiary. I will also attempt to briefly outline the use of Spousal Trusts and Henson Trusts. Before going on in this article we need to define the parties in the trust:

• The settlor is the person who is putting property into the trust.

• The beneficiary is the person who will receive the benefits of the trust

• The trustee is the person becomes the legal owner of the trust property and is responsible for administering the trust in accordance with the instructions set out by the settlor.

The following are reasons for using trusts in estate planning:

• Trusts can be used to control how assets will be spent by giving the trustee the authority to control the assets.

One would see this type of asset used where the beneficiary is not responsible enough to manage the assets wisely.

• Trusts are an excellent means of minimizing tax by perhaps deferring capital gains or providing a mechanism to take advantage of the tax planning tools since trusts are taxed as a separate individual

• Property held in a trust does not fall into the hands of the creditors of the settlor.

So you may be asking yourself how does one save taxes by using a trust. Well let’s begin by realizing that a trust is distinct from the settlor and the beneficiaries. A trust in essence is another individual who would have the same graduated scale as the beneficiary would have for his personal tax reporting.

Let’s assume that a farmer leaves farm property to one child and investments funds to another child. The child inheriting the investments funds is already in a high tax bracket due to the income he\she is already earning. The income earned by the investments would therefore be charged in the highest tax bracket. Since the trust is treated as an individual the trust income would be taxed according to the same graduated scale applied to personal income tax.

Another scenario may see a parent leaving money to a spouse to be used to finance their children’s education. If the surviving parent is financially independent and already paying the high rate of income tax the earnings from the money for the children would be added to her income and she would pay her top marginal tax rate. If left in trust to the children each child would have their basic personal exemption and as a result there would be a lot less going to CCRA and more for the children for whom it was intended for.

Spousal Trusts

A spousal trust is set up when one person passes away and leaves property to their spouse but they would like to ensure that the property ends up in their children’s possession after the surviving spouse passes away. For example let ’s assume that a farmer left his farm and investments to his spouse and wanted his children to eventually own the farm. He could put his assets in a spousal trust which would allow his spouse to use the growth on the assets and the income of the farm but the surviving spouse could never sell the farm. This way if the spouse remarries the property is protected if that spouse passes away and would not become property of the new spouse. You should be aware that there could be problems with this arrangement under the Family Law Act.

Henson Trust

If parents have a disabled child they should consider a Henson Trust. By putting funds into a Henson Trust the child may be able to receive benefits from the trust and at the same time these benefits would not affect any government subsidies. If a Henson Trust is not used to hold assets for the disabled person, funds received by a disabled child will offset government assistance programs.

There are other issues with trusts such as possible attribution rules and the 21 year rule among other things.

If you feel that a trust may suit your planning needs please give us a call and we can discuss it. If you wish to proceed we will work with you and your other professional advisors to implement such a plan.

Disclaimer –Neither Freedom 55 Financial, a division of London Life Insurance Company or its financial security advisors are engaged in the giving of tax, legal or accounting advice. You should seek independent professional advice from your lawyer and/or accountant before implementing any concepts discussed on estate planning.

FALL 2006

The Most Imporant Document You Will Ever Draft

Len Davies– Davies Legacy Planning Group

How up-to-date is your will? Does it address your current wishes if you were to die tomorrow? Or worse yet do you have a will? Your will is probably the most important document that you will draft in your lifetime. You have worked hard to create an estate and your will will ensure that your estate is distributed according to you wishes.

What will my will accomplish?

A comprehensive will should accomplish the following:

• Designate who the executor of your property will be.

• Outline the authority that your executor has in settling your estate.

• State who your heirs are, how much they will receive and when they will receive it.

• Determine how your assets will be handled.

• Who will take care of your children?

Who will my executor be?

Your executor should be someone who understands your wishes, is familiar with your farming operation, and has the respect of your beneficiaries. I strongly suggest that you chose more than one executor or designate an alternative executor since one may predecease you, move away or not be interested in acting in this position when your death does occur.

Chose an executor(s) who can adequately carry out the duties listed:

• If your family has not already done so, arrange and pay for your funeral.

• Notify professionals of death – lawyer, banker, financial planner, insurance agent etc.

• Locate your will and work with a lawyer to finalize your estate.

• Pay all final expenses such as probate fees and taxes.

• Arrange with your life insurance company to have the insurance proceeds paid.

• Fill in the designated forms to collect the death benefit from Canada Pension.

• Complete necessary financial documents such as a balance sheet for your property.

• Settle your estate by disbursing designated property in the best interests of your heirs.

• Hire an accountant to file your final tax return.

Approaching your solicitor

Before you sit down with your solicitor have some idea of what you would like in your will. You most likely have some thoughts in your mind as to how your will should be drafted. People tend to think of what they would like to see happen if just they died but you need to think of what you would want to happen if both you and your spouse died. Or perhaps you are farming with a child. Think of what would happen if you and your farming child were to pass away in an accident at the same time. Now what would you like to see happen?

At this point you should discuss your tentative plans with other professionals such as your financial planner and your accountant. By working with the different professions, it will ensure that all legal, tax planning and other estate issues will be adequately addressed in your will.

SPRING 2006

Find Yourself a Quarterback

Len Davies– Davies Legacy Planning Group

Over the las t few year s I have conducted a number of financial planning seminars with farm operators across Ontario. It became quite evident that the topic of most interest was succession planning. One of their biggest concerns was “getting the succession planning process started.” Owning a farm and being part of the baby boom generation, I can certainly empathize with others who are trying to come to grips with this process. It’s easy to put it off into the future, since we feel we still have lots of time ahead of us. But in reality, it’s better to start now. So, where does one start?

Find yourself a quarterback

The first step in creating a succession plan is to find yourself a quarterback to facilitate the process. A quarterback is someone who understands the process needed to develop an effective succession plan. Your quarterback will get your process started and follow it through to make sure that the process is completed. The following are some of the duties of a good succession quarterback.

• Help the family understand his/her role as quarterback and ensure they’re comfortable.

• Conduct a family meeting in a business-like fashion.

• Encourage the family to discuss all the issues on succession planning for their farm enterprise.

• Make sure the family realizes there is a difference between fair (equitable) and equal division of farm assets.

• Work with the family to determine the goals and objectives of their succession plan.

• Make sure that the family is aware of the tools available to transfer farm assets.

• Insist on open communication and ensure everyone has an equal voice in the discussions.

• Ensure the family takes into consideration all aspects of the transfer. i.e. labor, management, profitability,and possible environmental constraints.

• Either take notes or appoint someone to take notes and distribute them to everyone involved. The notes from the previous meeting should be discussed to make sure everyone understands where the process is headed.

• Keep members of the family who are not present at the meetings upto-date on decisions. Discuss the objectives of the succession plan when all members of the family are living will avoid potential problems later.

• Help the family develop a general plan for the transfer of assets.

• Once the family feels comfortable with the planning process their team of professional advisors need to be consulted. The farm families’team may consist of their creditor, financial consultant, accountant and lawyer.

Your quarterback is only the catalyst for your plan – it’s your plan not your quarterback’s plan.

Finding the right quarterback is onlyone of many things that need to be considered in the succession planning strategy. In future newsletters I will discuss other aspects of farm business succession planning.

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