Planning For Retirement As A Business Owner

As a business owner, you've likely spent a great deal of time and energy cultivating and growing your business. It's crucial to ensure that you've not overlooked the importance of planning for your retirement. Gen X and Gen Y business owners need to know that it's never too late to start, nor too early to begin, and the rewards of strategic planning can be substantial. We'll dive into the essential elements, such as risk management, estate planning, investment management, tax planning, and exit planning.

The Earlier, The Better

Many financial advisors agree that the ideal time to start saving for retirement is as soon as you start earning. As a business owner you must weigh putting money away vs reinvesting in your business, but the power of compounding interest cannot be overstated.

When you start early, you have the luxury of saving less each year to reach your goal, thereby making the whole process less stressful. You are also prepared if your business does not sell or sells for less than what you planned. Don’t despair if you haven’t started yet. You can still make significant strides towards your retirement goal, but you might need to save a higher percentage of your income to catch up.

Consider two individuals, Evan, and Fran. Both plan to retire at 65, but they start saving at different stages of their lives.

Evan starts saving at age 35. He invests $20,000 annually in a 401(k) that provides an average annual return of 7%. After 30 years, at age 65, Evan will have contributed a total of $600,000 ($20,000 * 30 years). However, due to the power of compounding, his retirement fund will have grown to approximately $2,006,278.

On the other hand, Fran starts saving later at age 55. She also invests $20,000 annually in a 401(k) with the same average annual return of 7%. However, after 10 years, at age 65, Fran will have contributed a total of $200,000 ($20,000 * 10 years). But, because she started saving later, her retirement fund will have grown to approximately $274,052.

Despite Evan contributing only three times as much as Fran, his retirement fund at age 65 is over seven times larger. This substantial difference is due to the power of compounding interest, underscoring the significant advantage of starting to save for retirement earlier rather than later.

These examples illustrate why, as a business owner, it's so crucial to start planning and saving for your retirement as soon as possible. Regardless of when you start, every step taken is a step closer to a more secure retirement. Even if you begin later in life, remember that it's still better than not starting at all, and each contribution you make is progress.

Estimating How Much to Save

Estimating how much to save for retirement as a business owner is more complex than for a salaried employee, largely because your income may be inconsistent, and a significant portion of your wealth may be tied up in your business. The value of your business at the time of sale, which will likely form a large part of your retirement fund, is uncertain. Fluctuations in the market, changes in your industry, and the state of your business at the time of sale can all influence its value. In addition, when you retire, certain expenses that you used to run through the business will now need to be funded out of your personal finances.

Here's what you need to consider:

Business Sale Uncertainty: Given the variability of business valuations, it's wise to be conservative in estimating how much you'll net from the sale of your business. Business valuations can be affected by factors such as market conditions, industry trends, business profitability, and buyer interest. Engaging a professional business valuator can help provide a realistic estimate, which can then be reviewed and updated regularly to account for changes in these factors. This is why every business owner should have a valuation of their business

Personal Expenses: When you're running a business, certain personal expenses might be paid for or offset by the business. These could include your vehicle, phone, internet, travel, or even some meals and entertainment. After you retire and sell your business, these costs will need to be covered by your personal finances. Thus, when calculating how much income you'll need in retirement, it's important to factor in these additional costs.

Desired Lifestyle: Think about the lifestyle you wish to maintain in retirement. Do you plan to travel extensively? Or perhaps you wish to pursue a hobby that could involve significant costs? Your retirement savings should adequately support your desired lifestyle.

Inflation: The cost of living will likely increase over time due to inflation. What seems like enough now might not be enough in the future. It's important to factor inflation into your retirement savings plan.

Healthcare Costs: Healthcare can be a significant cost in retirement, especially if you require long-term care or specialized medical services. While it's challenging to predict these costs, planning for this expense is crucial. As a business owner this is often overlooked because you probably cover most or all the costs through the business.

A commonly used rule of thumb is to aim to replace 70-80% of your pre-retirement income during retirement. However, as a business owner, you might need to aim higher to account for the factors mentioned above.

A financial advisor can help you make a detailed, customized retirement plan based on your individual circumstances, including your business's estimated value and the shift of expenses from your business to your personal account in retirement. Financial Planning for Business Owners is different. Regularly reviewing and adjusting your plan can help ensure that you are on track to meet your retirement goals, despite the uncertainties and unique challenges you face as a business owner. Remember, it's not just about saving a certain amount, but about saving smart and making sure your retirement savings will work for you when you need them.

Risk Management

Risk management is an integral part of financial planning, particularly for business owners who may encounter unique risks and uncertainties. A comprehensive financial plan is often built on the assumption that things will proceed as expected. However, life can be unpredictable, and adverse events can threaten the best-laid plans. How can you go about protecting your business financially against the unexpected? it's crucial to have a robust risk management strategy in place to ensure the success of your financial plan, no matter what life throws at you.

Here are the key components of a successful risk management strategy:

Emergency Fund: An emergency fund is a cash reserve that can cover three to six months of living expenses. It can provide a financial safety net in case of unexpected expenses or income loss. Having this fund in place can help prevent the need to dip into your retirement savings prematurely or to hamstrig the cash flow of your business.

Insurance: As a business owner, you likely already have insurance policies for your business. But have you thought about how health issues, disability, or death could affect your personal finances and retirement plan? Personal insurance can protect you and your family from such risks. Here are some types of insurance you may need:

Health Insurance: Even with a healthy lifestyle, medical emergencies can occur. A comprehensive health insurance policy can help cover medical costs and protect your retirement savings.

Disability Insurance: If an injury or illness prevents you from working, disability insurance can replace a portion of your income, helping to ensure your retirement plan stays on track.

You can also put disability insurance in place to pay the bills of the business if you are sick or hurt and can’t work thus ensuring you have a business to get back to.

Life Insurance: Life insurance can provide financial support to your family in the event of your untimely death. The death benefit can be used to cover living expenses, pay off debts, and even contribute to retirement savings, ensuring your family's financial security.

You can also put in life insurance to protect the business against the death of a business partner or other key employee.

Long-term Care Insurance: As you age, the likelihood of needing long-term care services increases. Long-term care insurance can help cover the costs of home care, assisted living, or nursing home care, preventing these expenses from draining your retirement savings.

Investment Diversification: Diversification involves spreading your investments across various asset classes (like stocks, bonds, real estate, etc.) to reduce risk. If one investment performs poorly, others might perform well, helping to balance out potential losses. A well-diversified portfolio can provide a steady growth rate for your retirement savings, even in a volatile market.

Regular Reviews: Risk management isn't a one-time activity. Regularly review your risk management strategies to ensure they continue to align with your current situation, financial goals, and risk tolerance. Changes in your personal life, business, or the economy might necessitate adjustments to your strategies.

Proper risk management and insurance planning will make sure that even if life throws unexpected curveballs your way, your retirement plan can weather the storm. When building your financial plan, it's essential to prepare not just for the best-case scenario but for the potential worst-case scenarios as well. It's about creating a solid financial foundation that will protect you and your family and ensure that your retirement years are secure and comfortable, regardless of the uncertainty’s life may bring.

Estate Planning

Estate planning is a critical element of financial planning, particularly for business owners. It ensures that your assets, including your business, are distributed according to your wishes after your death. It's not just about preparing a will – establishing trusts and creating a succession plan for your business are equally important. Here is what every business owner should know about estate planning.

Trusts and Wills

A will is a fundamental estate planning tool that allows you to dictate how your assets should be distributed after your death. Without a will, the state will determine the distribution of your assets, which might not align with your intentions.

However, a will alone may not be sufficient, especially for business owners with significant assets or complex situations. This is where trusts come into play. Trusts are legal entities that hold assets on behalf of beneficiaries. Should a trust be part of your estate plan? They offer several advantages:

Avoidance of Probate: Assets held in a trust bypass the probate process, which can be time-consuming and costly. This means that your beneficiaries may gain access to these assets more quickly.

Control Over Asset Distribution: A trust can provide more control over how and when your assets are distributed. For instance, you could set up a trust to distribute assets to your children when they reach a certain age or to provide for a disabled family member.

Privacy: Unlike a will, which becomes part of the public record, a trust can keep the details of your estate private.

Tax Planning: Certain types of trusts can provide tax benefits, reducing estate taxes that might otherwise significantly erode the value of your estate.

The use of trust and wills should be tailored to your specific circumstances and goals. An experienced estate planning attorney can help you navigate this complex area.

Business Succession Planning

For business owners, your business is often your most significant asset, and deciding what happens to it when you retire, become disabled or pass away is a crucial part of your estate planning. Everybody leaves their business, either willingly, such as retirement or a sale, or unwillingly, through death or disability. Your only choice is whether you plan and make it orderly or don’t plan and let chaos rule. Business succession planning involves deciding who will take over the business or if it will be sold and setting the processes in place for that transition.

Choosing a Successor: The successor could be one of your family members, a business partner, or even a key employee. It's essential to choose someone with the skills and desire to take over your business.

Training and Transition: Once a successor is chosen, they need to be prepared for the role. This might involve training or gradual delegation of responsibilities.

Legal and Financial Structures: The transition process needs to be formalized legally and financially. This might involve revising the business structure, drafting buy-sell agreements, or setting up trusts.

Tax Considerations: It's important to structure the succession to minimize tax liabilities. This might involve strategies like gifting shares or setting up a family limited partnership.

Contingency Planning: It's also essential to have a contingency plan in place in case you're suddenly unable to manage the business due to death or incapacity.

Estate planning, including setting up trusts and creating a business succession plan, is complex but necessary to ensure that your assets and business are passed on according to your wishes. It can provide peace of mind, knowing that your loved ones and the business you've built are well provided for. It's highly recommended to work with legal and financial professionals who specialize in estate planning and business succession to ensure all aspects are properly addressed.

Investment Management

Investment management involves strategically allocating your assets to reach your financial goals. As a business owner, it's crucial to ensure your investments are diversified beyond your business. While it may be tempting to reinvest all your profits back into your business, remember the adage "Don't put all your eggs in one basket." Having a diversified investment portfolio can help cushion against market fluctuations and business-specific risks.

Employees of publicly traded companies are often granted company stock as part of the compensation package. From a portfolio management perspective, holding outsize amounts of stock in the same company that provides income can increase risk. If the business were to become wobbly, not only would the stock decrease in value, but the employee could also potentially find themselves out of a job. Employees who are granted stocks often mitigate this risk by selling some of the company stock and reinvesting it in other assets, to diversify growing wealth away from the source of income.

But what about when you own your business? The situation becomes more complex. One strategy that’s often followed is to put everything except living expenses back into the business while you are growing it, and then sell part of the business or take on a strategic investor to help you begin to diversify elsewhere. Retirement planning is put on the back burner until the business has grown to a point where the business can be monetized.

We think there is a more thoughtful approach that may work for business owners.

The Key: Diversification

While it may seem like a good idea, relying solely on your business as your source of wealth can expose you to a lot more volatility than you think. Whether it’s saving for a rainy day, or longer-term goals like retirement, if all your wealth is tied up in your business, your business dictates your moves.

Creating and regularly adding to a separate investment portfolio may help diversify your assets.? And if you invest away from areas you are already exposed to in your business, it can be a powerful tool to help you smooth volatility across both your business and life.? For instance, if your business is vulnerable to cyclical sectors, you’ll want to create an investment portfolio that is defensive against those sectors.

Retirement Savings Tax Advantages

There can be significant tax advantages to setting up the right kind of retirement plan for your business and ensuring that you set aside money to invest as close to the maximum as possible every year. While there are of course upfront fees and ongoing costs associated with formal retirement plans, they also allow you to save in a very tax-advantageous manner. Depending on your situation, a 401(k) plan and a cash balance plan are tools you can use to save and look towards a future income stream you can access without having to sell your business. They can also be a great way to attract and retain talented employees. Here is an article I wrote to help you in choosing the right retirement plan for your business.

How About Timing?

When you’re putting everything back into your business with the idea that you’ll eventually fund your retirement by selling all or part of it, you’re essentially making two bets: That you’ll be able to sell when you are ready and not before, and that when you are ready the market for your business will be at a good point for an exit.? Having to liquidate early because you are no longer able to run the business, or having to sell when either the business is struggling or the market isn’t right, can limit the amount you realize. You only get to sell it once, and your retirement life will be dependent on what you realize. If you’ve planned for a source of retirement income away from your business, you’ll have more flexibility when it comes time to sell.

The Bottom Line

Even as you’re building your business, it makes sense to think about your personal wealth as a completely different stream of future income. Thinking about diversification across your total asset profile can get you started on a journey to financial independence.

You should also balance your investment portfolio based on your risk tolerance and time horizon. The closer you are to retirement, the more conservative your investments should be to protect what you've saved.

Tax Planning

Tax planning involves strategies to minimize your tax liability now and in the future. As a business owner, there are several ways to maximize the tax advantages of business ownership. For example, consider a Simplified Employee Pension (SEP) IRA or a solo 401(k) plan. These retirement accounts have higher contribution limits than traditional IRAs, providing the potential for larger tax deductions. What makes sense for you depends on your objectives and stage of your business.

Additionally, consider the impact of taxes on your estate plan. For instance, gifting assets to your heirs during your lifetime can help reduce your taxable estate.

Exit Planning

Exit planning involves preparing for the day you leave your business. Whether you plan to sell, pass it on to your children, or potentially close it, having a plan in place is essential. Start by determining the value of your business. Then, identify potential buyers or successors, and groom them if necessary.

Here are 5 ways to sell your business.

Additionally, consider the timing. Selling your business when it's doing well will likely yield a higher price. Lastly, consider the tax implications of selling your business and how it will contribute to your retirement income.

Planning for retirement as a business owner is multi-faceted but vital. By starting early, saving strategically, managing risk, planning your estate, diversifying investments, and planning your business exit, you can ensure you're financially comfortable in retirement.

You don’t have to do all of this on your own. Engaging a financial advisor with experience helping business owners can make this process smoother and more effective. Remember, it's never too late to start planning for your retirement.

Did I mention that I AM A FINACIAL ADVISOR WITH EXPERIENCE HELPING BUSINESS OWNERS? If you would like to see how

BOOK AN APPOINTMENT HERE

With each passing day, you have an opportunity to take steps towards securing your future. So, don't delay, start your retirement planning today. Your future self will thank you for it.

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