Life insurance fertilizes next generation of farmers

A family business is usually sold or taken over by the children or, sometimes, a long-time employee. In these cases, it is often difficult for the successor to afford an appropriate acquisition price; however, it is important to properly compensate the retiree for their years of hard work. To satisfy the needs of both parties, there are creative succession planning techniques that address the complexity of the situation more fairly.

The family farm is a good example of how these issues can affect not only the future of the business but the family itself. “Farms tend to have large assets, such as land, with great potential for development; however, they often do not have large financial assets,” says Kevin Vaughan, a Peterborough, Ontario-based Financial Advisor with a specialty in Farm Estate Planning. “In fact, farms tend to have large debt loads. This makes it difficult to finance retirement in a way that doesn’t jeopardize the business or the family’s harmony.”

Family farming in Canada has been tackling these issues innovatively for years using family trusts, equity sales, wills, and life insurance policies as integral components in smart succession planning.

From a tax perspective, the family farm does have some unique advantages when transferring farm assets to the next generation. For instance, the younger generation can inherit farm assets tax free; however, this does not address the short-term cash needs of the transferring farmer.

To make the farm transfer mutually beneficial and actually viable, a life insurance policy needs to be added into the financial plan mix. Life insurance in its simplest form can be described as “guaranteed future tax-free dollars at a discount,” says Vaughan.

Here’s how it works

The most common recipe includes a mortgage and a life insurance policy to create an orderly and well-financed transition between parents and the next generation owners.

The Mortgage

To start, the parents would transfer the real estate to the next generation owners. Then a mortgage is taken out against the property to fund the parents’ retirement, at a consistent standard of living.

The Life Insurance

The children would purchase a joint first-to-die insurance policy on the lives of their parents, in the amount of the mortgage and interest payments. This strategy avoids long-term burdensome debt while allowing the children to properly compensate their parents during the business acquisition.

The farm corporation could own the policy, pay the premiums and be the beneficiary. The policy would provide tax-free cash to the farm corporation upon the death of either parent. When this happens, the children will use the cash to eliminate the mortgage used to transfer the assets and fund the parents’ retirement. As such, the transition and retirement cost will be only as much as the combined premiums paid.

We believe that other industries can benefit by adopting the succession strategies that have been prevalent in farming. Life insurance can be part of comprehensive succession plan for a family-owned business in almost any industry.

James Hilton and Cameron Jacox are the Managing Partners of Jacox-Hilton, a firm that works with financial advisors and Managing General Agencies to enhance value delivered to clients. In addition, Jacox-Hilton works directly with businesses to provide valuation services for succession planning.