The Basics Of Pre-Retirement Planning
For Small Business Owners
There comes a time when an owner of a small business must ask two crucial questions: (1) How can I maximize the value of my business when I retire? And, (2) will the value of my business be adequate to fund my retirement years?
Business owners who fail to ask these questions until later in life may find themselves in shallow financial waters. But those who plan their exit strategies earlyworking with an experienced financial advisorshould be well positioned to transfer their businesses to new owners.
When working with small business owners, the financial planner should focus first on family or personal goals. This means gaining an understanding of the business owners long-term vision separate from the business. They then can devise a plan to help the owner maximize the profitability of the business and, thereby, secure the owners retirement.
The business owner and financial planner must surmount the financial obstacles that exist for small business entrepreneurs. Example: taxes exceeding 15% of gross income in Social Security contributions. They also pay health care benefits with no subsidies and all life benefits.
If they get sick or hurt and cant work, they have to figure out how to fund current expenses. If they die prematurely, they have to honor leases and debts of the business and provide income for surviving family members.
A common mistake small business owners make is having all their net worth in the business. In some cases, they spend years putting money into improvements on property they dont own.
For example, one of my clients, a small business owner, leases a 5,000-square-foot office space. He recently spent thousands of dollars installing granite countertops. When he leaves the business, this expenditure will have no positive impact on his retirement income.
Closely held business owners also must be aware of unique risks attached to their retirement savings. When a business owner signs leases or guarantees debt as a normal part of business operations, creditors can attach the individuals savings.
Business owners must therefore be vigilant in risk assessment by asking such questions as: If I get sick or hurt or die, who can take my money away from me or, more importantly, my family? What choices do I have? What tools do I have to preserve some of my wealth?
A financial planner can help the business owner answer these and other questions. Together, the owner and planner can focus on retirement goals and plan carefully to defer current income to fund the owners retirement years.
A planner also can help business owners determine an exit strategy, defining the desired retirement lifestyle, and timing the retirement date to coordinate with lease expirations and debt repayment schedules.
Once this information is gathered, the planner can help the owner determine how much money, factoring in inflation during the retirement years, he or she will need to support that lifestyle. The planner can then calculate how much equity or value must be saved outside the business to achieve financial independence. I call this the Walk-Away Fund.
Another of my clients is a 41-year-old commercial building contractor who has been in business more than 20 years and wants to retire in 10 years. His average income is $500,000 a year in pre-tax income and his current savings are less than $200,000.
To create a financial plan, we first looked at where his money was going. We did a cash flow analysis to determine how much leftover income he would have at the end of the year, after tax. Then we determined how much in annual income he would need to meet his retirement lifestyle goals: $110,000.
Our next task was to figure out how much money he needed to save to create that income, given his and his wifes risk for tolerance and volatility. As part of this process, we created a budget that he and his family must diligently follow for 10 years.
Two other clients are partners in an executive recruiting business. They are in their early 50s, have incomes of about $300,000 a year and have $300,000 to $500,000 in savings. Aware that their business will have little value to a buyer, they intend to lock their doors and walk away from the business 10 years from now.