Retirement for business owners: Don’t put all your (nest) eggs in one basket

For many small- to medium-sized businesses, the owner's single largest investment is the business itself. The retirement plan is to live off the sale of his or her life’s work.

This approach may provide incredible benefits, but also carries some unique inherent risks. Those risks are often exacerbated by the fact that the owner’s spouse may work in the business, as well, which means the couple’s retirement nest egg is all in one proverbial basket.

It’s easy to understand how and why this happens. For businesses of roughly 100 employees or less, the business and the owner are practically one and the same — it’s difficult to distinguish the value of one from the other. In fact, your business is often successful because you put your sole focus and invested all your energy into its livelihood.

It’s the nature of the beast.

The best way to safeguard that investment and create the retirement lifestyle you’ve been expecting is to build in a fallback plan through diversification. It’s never too late to get started.

The risks and rewards of 'my business is my retirement'

As a financial planner, one of the most common things I hear when talking to small business owners is, “My business is my retirement.”

You’re not alone when it comes to this approach, and believe me, this method can be effective. In addition, building your own business over the years often feels like a more stable retirement solution because owners feel some sense of control over their future.

The downside is that it is actually much more volatile and unpredictable than the more standard approach of retirement planning. For example:

  • Global events can impact your bottom line. From wars in other parts of the world to weather catastrophes, raw materials can unexpectedly become unattainable.
  • Markets change with new innovations. I’m sure typewriters felt like a sure bet before computers came along. Calculators, radios, watches, and cameras are all on your smartphone these days. You can’t imagine that your business will become obsolete until something you can’t imagine hits the market.
  • Recessions affect business valuations. I’d love to say I can predict the next big downturn in the economy, but we really only guess at generalities in the market. An unexpected recession can leave you wishing you had retired last year — and require you to continue working or take much less than anticipated.

A more reliable approach is to diversify your retirement dollars independent of the business so you have multiple “baskets” to protect your future.

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Tap into underutilized solutions

A wealth management professional can help you identify additional “baskets” to consider, as well as suggest ways to structure those options appropriately, such as:

  • Participating in the employee retirement plan. This is particularly important if your spouse also works in your business and has no outside retirement source to supplement what will come from your business. Most companies do have some kind of plan in place for employees. Take advantage of this simple opportunity to diversify.
  • Maximizing safe harbor and profit sharing. If you maximize the 401(k) retirement plan by contributing 4 percent on behalf of participating employees, then your highly compensated group of employees — including the owner — aren’t limited on what they can contribute to the plan. In 2019, employees 50 years and older can contribute $25,000 of their own money into a tax-advantage plan. You can also add a profit-sharing contribution in good years and sometimes skew the benefits toward yourself using a cross tested (permitted disparity) profit-sharing formula.
  • Investing in long-term care insurance. One of the biggest threats to ongoing financial health is long-term care expenses. This is true whether you’re a business owner or not. Establish a group long-term care program at your company. There may even be a tax deduction back to the business owner for this kind of coverage. Check with your tax advisor for more information.
  • Considering voluntary after-tax contributions (VATC). There are limits on pre-taxed retirement contributions for individuals. However, after-tax contributions can more than double those limits. This is a feature in some 401(k) plans and doesn’t work in all cases. Check with your 401(k) administrator.
  • Looking into Roth contributions and in-plan conversions. The IRS eliminates the ability to make Roth IRA contributions if you make too much money. If your 401(k) plan adds this feature, you can make Roth contributions up to the salary deferral limits mentioned above. Adding an in-plan conversion would allow you to convert previous pre-tax contributions to Roth dollars, which would make them tax-free when withdrawn. Business owners might consider this strategy in a year they have large losses to claim on their taxes since the converted dollars are taxable.

Get the most from your sale

You have taken steps to put your eggs in multiple baskets, but the sale of your business is still a major source of your retirement income. Maximize the return on the sale of your business with the help of a team of financial professionals, including:

  • A business valuation expert to establish a sale price backed by market analysis and financial review of your company;
  • An accountant with business-specific expertise to provide tax guidance;
  • An attorney who can structure a buy-sell agreement with the owner’s retirement plans in mind. Many owners believe they will receive the entire purchase price immediately and have all cash available on day one. However, there may be situations where a long-term buyout over time makes sense for both parties; and
  • A wealth management expert to help protect your investment before retirement through preparation and diversification and after retirement by managing the income from the sale of your business by helping you establish a plan that respects your quality of life expectations without sacrificing your long-term needs.

Retirement should be a time to reap the fruits of your labor. As Fred Rogers from Mister Rogers’ Neighborhood said: “Often when you think you’re at the end of something, you’re at the beginning of something else.”

Enjoy your “something else” down the road by protecting your investment now.

Jeff Supple, certified financial planner and certified trust and financial advisor, is a vice president and trust officer at State Bank of Cross Plains (SBCP).

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