Many farmers want to see their family farm carry on to the next generation. This may not sound like a tall order but it can be. The ability for a son or daughter to take over the family farm has become increasingly difficult.
Why so complicated? A family farm like any business, comes with a great deal of work, financial challenges and strings attached. Unfortunately, the result can be the death of some small family farms as we know them.
My husband Ken, who is my business partner, specializes in farm succession planning. He shares their passion for farming, and we have seen many farm situations over the years. In our financial business, there is a need for farm succession planning to help family farms survive. Farming can be challenging, and farm families look to us for financial strategies to help their farm continue into the next generation.
Let’s take a look at a farming couple with four children and a farm valued at one million dollars. Two children would like to carry on the family farm, and two are not interested in farming.
Another couple, with no farm but with one million dollars in the bank and four children, would likely give $250,000 to each child as inheritance upon their deaths. Separating money is easy. A farm is not so simple. You can’t split up a farm like that. It needs to stay intact for the farming children to make it work.
If the farming couple leaves the farm to all four kids, the two farming children would need to buy out the two non-farming children. In this scenario, the two farming children take out a mortgage for $500,000 in order to pay $250,000 to each of the other two siblings for their share.
It may seem simple, but this scenario can cause a significant financial burden for the farming children. Taking on this kind of debt and keeping the farm afloat may not be feasible.
If amortized for 25 years at 4% it would mean the farming children paying over $791,000 by the end of the term with principal and interest. In addition, they take on the farm expenses and work load. Can they afford to keep the farm above water? Do their numbers work out? Will they be forced to sell the farm if they can’t make ends meet?
The farming couple understand the challenges of farming and want to provide every opportunity for the farm to succeed. The discussion often begins at a time when the farming children are becoming actively involved, putting sweat equity into the operation, and begin taking over all or part of the farm. This is when farm succession planning becomes part of the discussion.
A farm valuation is determined and frozen for estate planning purposes. A plan is created for the equalization amount. To keep with the same example, in this case, a $250,000 buy-out per non-farming sibling.
As a succession option, instead of taking out a mortgage for $500,000 upon the death of the farming parents, consider a joint life insurance contract on the lives of the parents for $500,000 to be paid out upon the last death. This $500,000 death benefit is then used to buy out the non-farming children. A problem that presents itself at death can be solved with a solution that pays out at death.
Consider the numbers; let’s say a male and female both aged 65 can be insured for a joint $500,000 life insurance contract to be paid upon the last death for a premium of approximately $9,800/year. For comparison, let’s go back to the same 25 year payment period we used in the mortgage example. After 25 years approximately $791,000 has been paid in principal and interest. The premiums paid into the insurance contract after 25 years are approximately $245,000. This makes the insurance a far more cost-effective succession financing option than the mortgage.
The contract should be designed for each unique situation. The life insurance contract is applied for immediately as it needs to be underwritten and acceptance is based on insurability. If there are significant health issues this planning strategy may not be an option. Future health concerns are another reason to have farm succession discussions early.
Using life insurance (health permitting) in farm succession planning allows for the farm business to pay pennies on the dollar for the estate equalization rather than multiple dollars on the dollar through loan financing. It reduces financial liabilities of the farm and allows the family farm to thrive into the next generation.
Each farm situation has many complexities and points of discussion to consider for each family. Sitting down with a farm succession specialist is the best way to get started to help sort through your own planning needs.
Farm succession planning helps farming families carry on their dreams of the inter-generational family farm. Farming is in the blood, they say. It’s a deep rooted, love of the land, and passion for farming that drives farmers to see their family farms succeed beyond their lifetimes. And this, for the farming family, is priceless.
Column appeared in November 2019 issue of This Month In Elgin
Stephanie Farrow, BA., CFP., Stephanie has over 26 years' experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning and Certified Financial Planner designation. Stephanie has been writing a financial column for local business magazine Elgin This Month/This Month in Elgin since 2010. Stephanie and her husband own Farrow Financial Services Inc. About our Farrow Financial Team.