Preparing to Transfer Your Farm to the Next Generation: Estimating Your Family Living Expenses
There are many factors to consider when deciding to transfer your farm business to the next generation. Open communication between the generations is a key is successfully navigating the farm transition process. As part of the conversation, the topics of profitability and income generation should be addressed, for both the retiring and new generations. If the farm business does not have the ability to provide the income and asset needs of both generations, then the likelihood for success is greatly reduced. Producers will often continue with specific enterprises on the farm business when the enterprise can generate enough income to cover short-run expenses; however, to ensure the longevity of the farm business, it should be profitable in the long run. Several factors influence profitability, such as input costs and commodity prices, but you should also consider the anticipated standard of living for the operation's farm families and current debt loads. Households often struggle to estimate their current living expenses, which makes planning for the future difficult. According to the 2016 Kentucky Farm Business Management (KFBM) Family Living Summary, family living expenses were $67,478. This number may be higher than you anticipated your current family living expenses; however, many families have trouble estimating their living expenses. Both the retiring and new generations need to calculate the amount of income they will need to generate from the family farm. This should be done separately, because the two generations will have a different set of needs. The retiring generation may need to consider long-term care planning, while the younger generation may be concerned about establishing college saving funds. Below are some points to ponder for both generations:
The first step in determining your retirement income needs is to calculate your current living expenses. If you already track your family living expenses on a monthly budget, then you are ahead of the game. If not, start a spending diary. Write down all of your expenses for a one-month period. The big expenses are normally easy to identify such as mortgage payments, insurance, taxes, and utility bills; however, the everyday expenses such as eating out, trips to the store, and even things like snacks at the ball field are much more difficult to track. It is important that you write down all expenses for one month because even the smallest expense adds up over time. Multiply your spending estimate by twelve. As you review your expenses; examples of other occasional expenses that you may incur include home improvements, medical expenses, federal and state income taxes, recreation/vacations, and automobile expenses such as a license, registration, insurance, and repairs. Add together the total of monthly expenses and occasional expenses; this number should give you a realistic idea of your spending needs. Next, consider each item that you listed in your spending diary as an occasional expense. Do you anticipate any of these expenses increasing or decreasing when you enter into retirement? Many families are able to pay off their home mortgage prior to entering retirement, so this may be a reduced expense. However, many couples anticipate traveling more, so this expense category may actually increase. It is also important to recognize that your expenses may change during retirement. For example, as you age your medical bills may increase. Nonetheless, with a little planning you should be able to determine a realistic income that will maintain your desired standard of living. Most retiring couples will not need to rely on the farm as their only source of retirement income; total all of your estimated retirement income from other sources, which may include social security, and investments, or employer retirement from off-farm work. After you subtract the total amount of other income sources from your estimated retirement needs, you will have a realistic figure for the amount of income that you need to generate from the farm.
Similar to the retiring generation, the younger generation needs to develop a realistic estimate of its yearly family living expenses. Follow the same steps as the retiring generation for creating a spending diary and estimating occasional expenses. As you review your anticipated yearly expenses, determine if there are expenses that may adjust up or down over the next several years. Are you planning on having a child or another child? Will your day care costs increase? Or, maybe your children will be moving into public school and your daycare expenses will decrease. Do you have a child that will be driving soon? You will not be able to anticipate all your future living expenses; however, you can develop a realistic estimate. Determine your sources of other income. Do you or a spouse have off-farm employment? Do you have rental property or other investments that generate income? Subtract your total off-farm income from your estimated expenses; the remainder represents that amount of income you would need to generate from the farm operation. As a reminder, the younger generation should be certain to include savings and investment in retirement accounts in their expense estimates.
Once you have determined the income needs for both generations, you will have a realistic projection of the amount of income needed to cover your current standard of living.