Retirement planning presents unique opportunities and challenges for owners of closely held businesses who have accumulated significant wealth. Developing a retirement strategy that aligns with your goals as a business owner as early as possible is a crucial step toward ensuring a successful transition to working less and maintaining your desired lifestyle.
Whether you’re just beginning to wade into retirement planning or looking to make sure your current plan maximizes your tax savings and retirement investment, consider these four established best practices we often recommend to business owners.
1. Build wealth outside of the business
Many business owners place a high value on growing their businesses—and rightfully so. As you’ve worked to develop your business, chances are you’ve put your own money into it. In some cases, this blending of individual and business interests can hurt your personal finances.
For most owners, the first step toward effective retirement planning is to start accumulating wealth outside of the business. Having access to funds that aren’t tied to your business is essential. No matter how profitable your business is or the amount of blood, sweat and tears you’ve put in over the years, there’s no guarantee it will be valuable when it comes time to retire and sell it.
2. Ask the right questions about your business
Once you’re committed to building a retirement plan and growing wealth outside of your business, it’s time to start digging into specifics. The best strategy depends largely on the kind of business you operate. Are your profits consistent over the year, or do you have a few big pay days each year? Do you have significant overhead costs?
It’s also important to consider how you pay yourself. Do you earn a small salary and keep profits from the business, or vice versa? Is your spouse involved in the business? What about your children or other family members?
By answering these (and more) questions, you and your advisor can identify the financial vehicles that will offer the most flexibility and tax savings for retirement.
3. Talk details with an advisor
Meeting with an advisor who understands the nuances of managing both personal and business wealth is a crucial component of retirement planning.
At Wescott, one vehicle our advisors have recommended for business owners is the cash-balance pension plan (CBPP). This retirement plan has grown in popularity in recent years, as it combines features of traditional defined benefit plans and defined contribution plans while allowing for significant contributions. A CBPP is ideal for individuals who own highly profitable businesses and want to maximize their retirement contributions while minimizing their taxable income.
We recently worked with a husband and wife team who were perfect candidates for a CBPP. They are both entrepreneurs and have been in business for about 20 years. They have high profit margins, consistent cash flow, very little overhead costs, and can confidently project profits three or four years out.
And while their business is highly profitable, it had created significant tax burdens for the couple. They needed a plan to reduce their annual taxable income, while also building up their retirement savings.
After learning about their unique business structure and taking into account their revenue streams, profitability and profit margins, we decided a CBPP was the right vehicle. By putting as much as $300,000 into the CBPP initially, we created an immediate tax saving of 40 percent. As part of the plan we’ve structured for them, they’ve been contributing annually and benefiting from immediate income tax savings and long-term tax deferral.
Setting up a CBPP was the right fit for this pair of entrepreneurs, but is not appropriate for small business owners with less consistent cash flow. For individuals working in less steady industries with higher overhead, more traditional savings methods like an SEP IRA may be better suited. With an SEP IRA, there is a maximum annual contribution rather than a minimum, allowing for more flexibility.
4. Find a model that matches your financial mindset
Ultimately, your retirement plan must reflect your business goals and investment priorities.
Take the example of one Wescott client who loathed being in debt, even when it came to growing his business. A few years ago, he identified new office space for his medical practice. Rather than taking out a mortgage, he paid for the property with personal savings. His plan was to continue working for at least 20 more years, and to continue building liquid assets outside of his business. Because he was relatively young, he still had time to put profits toward retirement.
Our client understood that despite his significant investment in his business, he may be unable to sell his practice at retirement. When we sat down to help him picture what retirement would look like—and what assets he would have—he was assured that even if his business declined, he would still own the building and would accrue enough personal wealth to maintain his lifestyle. Rather than choosing more traditional investment options like stocks or bonds, he chose to own a valuable piece of property. And the peace of mind that came from being debt-free month-to-month was a worthwhile tradeoff for him.
While some retirement strategies can be very lucrative for business owners, specifics matter. Working with an experienced advisor who can look at business factors like cash flow and profitability while taking your personal financial mindset into account is the best way to decide on a plan that makes the most sense for you.
For more information on the most effective way to plan for retirement and reduce tax burdens, contact Wescott Financial.