FP Answers: Does it make sense to take a pension and invest in a farm?

Fernando plans to start a small farm to house a pension transfer. But is there a better way to shelter this money from taxes?

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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 room, which will leave me with about $270,000 in taxable income. I have a small staging and renovation business that I will be able to take tax deductions on, but only a few thousand dollars in business expenses. My wife Noreen and I are planning to start a small farm. If I invest this money in farm land and supplies, will I be able to deduct this cost from my taxable income for that year, even if the farm does not generate any income immediately? Is there a more effective way to shelter this money from taxes? —Fernando

PF responses : Hi Fernando. If you leave an employer where you had a defined benefit pension plan, the entire commuted value may not be taxable. Typically, the plan sponsor offers you the option of converting the pension into two amounts when you leave a pension plan. This transfer estimate may indicate that “locked-in” and “taxable” amounts result. The important amount to consider here is the taxable part, which will result in additional taxable income in the year of conversion.

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An RRSP contribution is an effective way to reduce the tax payable on the taxable portion of your pension transfer. You may have more than $25,000 in RRSP contribution room, as income earned from 2021 would increase available room (less any pension adjustment).

The tax-free portion of your pension can be transferred to a locked-in retirement account (LIRA). A LIRA is like an RRSP in that you only pay tax when you withdraw money from it. You do not have to make any withdrawals from this account until the year you reach age 72. If you want to take annual payments from the LIRA, you have the option of converting it to a life income fund (LIF) account. Taking early withdrawals is often advantageous. A LIF can also be used to purchase an annuity from an insurance company.

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Once you have converted the transfer value, you will be required to make minimum LIF payments each year based on your age or the age of your spouse. You also have the option of taking more than the minimum payment, up to a maximum under the federal or provincial legislation of your pension plan.

Additionally, you may be able to unlock part of your LIRA when you convert it to a LIF and transfer that amount to your RRSP. This release allows greater flexibility on the amount you can withdraw each year. It is important to note that unlock rules vary from province to province.

Your employer has probably offered you the option of receiving a monthly pension rather than a commuted value. One of the benefits of a cash value is that you would have more control over the timing of payments, especially if you unlock 50% in an RRSP when converting from the LIF. You can also control how you invest the pension amounts.

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In your scenario, taking the cash value means there may be a high taxable portion. Without deductions to offset the taxable amount, your pension may be taxed at a very high marginal tax rate.

Another downside is that you may not be able to generate the same retirement income if your investments are not performing well. If you live to age 110, you will continue to receive a monthly pension, but a LIF account may not survive you.

Another key difference between monthly pensions and discounted pensions is how they are treated upon death.

For cash values ​​transferred to a LIRA/LIF, you can designate 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 children, which can be appealing if you’re in a second marriage. A monthly defined benefit pension can usually only have a specific percentage paid to your spouse after your death, not your children.

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And do not forget that the higher the guarantee, the lower the amount of the pension. Defined benefit pension plans can also be indexed to a specific percentage of inflation, which can provide better inflation protection than investments in a LIRA/LIF.

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If your small business is operating at a loss and your income is negative, this could be a way to lower your overall tax bill. Keep in mind that there must be a reasonable expectation of profit in order to claim these deductions.

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Land and farm supplies are generally capital expenses, not current expenses, so they may not be tax deductible from your pension income. Capital expenditures are generally amortized annually over a number of years and give rise to tax deductions over time.

Whatever you do, Fernando, know that this is an important financial decision and you should get good 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) fee-only/advice-only at Objective Financial Partners Inc.

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