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Fernando considers starting a small farm as a way to accommodate a retirement transfer. But is there a more efficient way to protect this money from taxes?
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February 04, 2022 • February 4, 2022 • 4-minute reading time • Join the conversation Fernando wants to use a pension transfer to invest in a small farm. Photo by Daniel Acker/Bloomberg files
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By Julie Cazzin, with Andrew Dobson
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Q: In 2022, I will receive a transfer value of my employer’s pension of approximately $295,000. I will have about $25,000 in Registered Retirement Savings Plan (RRSP) contribution space, leaving about $270,000 in taxable income. I have a small staging and renovation business that I can take some tax deductions from, but only a few thousand dollars in business expenses. My wife Noreen and I are thinking about starting a small farm. If I invest that money in farmland and supplies, can I deduct those costs from my taxable income for that year, even if the farm doesn’t generate income right away? Is there a more efficient way to protect this money from taxes? — Fernando
FP answers: Hi Fernando. If you leave an employer where you had a defined benefit plan, the full surrender value may not be taxable. In general, the pension sponsor offers you the option to buy the pension in two amounts if you leave a pension plan. This transfer estimate may indicate that there are resulting “locked-in” and “taxable” amounts. The amount that is important here is the taxable part, which results in extra taxable income in the year of surrender.
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An RRSP contribution is an effective way to reduce the tax payable on the taxable portion of your retirement transfer. You may have more than $25,000 in RRSP contribution leeway, as the income earned from 2021 onwards would increase the available leeway (minus any retirement adjustments).
The non-taxable portion of your pension can be transferred to an escrow account (LIRA). A LIRA is like an RRSP in that you only pay taxes when you withdraw money from it. You do not have to withdraw money from this account until the year you turn 72. If you want to receive annual payments from the LIRA, you have the option to convert them into a Life Income Fund (LIF) account. Early withdrawal is often advantageous. An LIF can also be used to take out an annuity from an insurance company.
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Once you convert the transfer value, you must make annual minimum LIF payments based on your age or your spouse’s age. You also have the option to take more than the minimum amount, up to a maximum based on the federal or provincial law of your retirement plan.
You may also have the option to unlock a portion of your LIRA when you convert it to a LIF and transfer that amount to your RRSP. This unlock allows for more flexibility over how much you can withdraw each year. It is important to note that the unlock rules vary from province to province.
Your employer has probably offered you the option of taking a monthly pension in lieu of a surrender value. One of the benefits of a converted value is that you have more control over the timing of payments, especially if you unlock 50 percent for an RRSP on LIF conversion. You can also decide for yourself how you invest the amounts of the pension.
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In your scenario, taking the surrendered value means that there may be a high taxable portion. With no deductions to settle the taxable amount, your pension may be taxed at a very high marginal tax rate.
Another drawback is that you may not be able to generate the same retirement income if your investments are not performing well. When you turn 110, a monthly pension will continue to be paid, but an LIF account may not survive you.
Another important difference between monthly and commuted pensions is how they are treated in the event of death.
For surrendered assets transferred to a LIRA/LIF, you can name your spouse as the beneficiary and the account can be transferred to them on a tax-deferred basis upon your death. Or you can name your kids, which can be appealing if you’re in a second marriage. A monthly defined benefit pension can generally only be paid a certain percentage to your spouse after your death, not to your children.
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And don’t forget: the higher the guarantee, the lower the pension amount. Defined benefits can also be indexed up to a certain percentage of inflation, which can provide better inflation protection than investing in a LIRA/LIF.
FP Answers: Can I retire in 15 years even if I’m still paying off my mortgage?
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FP Answers: Should I sell my house, invest the money and rent it?
If your small business is at a loss and your income is negative, this can be one way to lower your overall tax bill. Please note that there must be a reasonable expectation of profit to be able to claim these deductions.
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Farmland and inventories are generally a capital cost and not an ongoing expense, so they may not be tax deductible from your retirement income. Cost of capital is generally amortized annually over a number of years and leads to tax deductions over time.
Whatever you do, Fernando, know that this is a big financial decision and you need to get sound tax and financial advice to make sure you make the right choice for you and your family.
Andrew Dobson is a Certified Financial Planner (CFP) and Chartered Investment Manager (CIM) at Objective Financial Partners Inc.
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This post FP Answers: Does it make sense to retire and invest in a farm?
was original published at “https://financialpost.com/personal-finance/taxes/fp-answers-does-it-make-sense-to-take-a-pension-payout-and-invest-in-a-farm”