When most people think about retirement plans, Social Security immediately jumps to mind. Next comes company pension plans. But those don’t help individuals who are self-employed or entrepreneurs and start their own small companies. What can they do to protect their retirement years?
Financial advisor Louis Barajas specializes in self-employed and entrepreneur clients, and offers his advice on where to start. Whether self-employed or entrepreneur, the process begins with mapping out how you expect your life to unfold. And in the case of entrepreneurs, it also means investing in the eventual retirements of the loyal workers that will be with you on the journey.
Q: Please tell us a little bit about your firm, who your clientele are, and what your specialties are?
Louis Barajas: We are a fee-only comprehensive financial planning firm and we really cater to two types of groups, which are entertainers and entrepreneurs. With entertainers, we’re kind of business managers and financial advisors to several internationally known Latino entertainers. And we also cater to people who are entrepreneurs. I started my firm helping out my father with his business. We have small businesses to medium sized businesses, and most days I work directly with the owner of each business; and retirees.
Q: In terms of your direct clientele, approximately what percent would you say are people that are self-employed?
Louis Barajas: I would say now about 60%.
Q: What are some of the major differences that a self-employed person faces in terms of their long-term retirement needs versus someone who is with an employer?
Louis Barajas: The biggest difference is what I call the roller coaster effect, which is cash flow. If you have an employer you get a check every single week, or biweekly, or monthly. They don’t have a predetermined check. Their paycheck will vary, based on their sales; the economy; a lot of different things. And so their money sometimes is very erratic. It is up and down like a roller coaster.
Q: How difficult is it to convince a self-employed individual that they should be making investments in their own retirement?
Louis Barajas: Instead of focusing on the strategies of what a retirement plan is, or which retirement plan would be best for them, I actually have a conversation about their personal lives 30 years out (depending on how old they are), and focus on what’s important to them. I get their mind off of focusing on the economics. I focus more on what their life is going to be like in 15 or 20 years.
Also, I focus on how they want to see their business completed 5, 10, 15 years out. I have them give me a vision of what their business would look like if were all complete and done, and they were ready to sell it. Then we go back and discuss, would you need any employees, or not need any employees? What kind of employees would you need? And if you needed them, how would you attract them? Would you attract them with having no benefits? Some benefits? Would a retirement plan be an inducement to attract good people—the kind that will work to help you grow the business to the vision that you’ve seen in your mind?
Maybe I am starting them off with retirement plans that aren’t very costly, so that at least there is a plan for the employees. If I focus just on them, they say ‘I can sacrifice on me in order to get the business to grow.’ But if I can actually tie the retirement plan as part of the growth of their business than all of a sudden they’re seeing it from a different angle.
Q: I would assume that because so many of your clients are entrepreneur types that they envision they will always be self-employed or always be working for a very small business and not see that as a temporary phase in life. Is that correct?
Louis Barajas: Yes. What happens is that once people get the taste of freedom, not having anybody looming over them, and they have the taste of controlling their own destiny—even if they at the point of really struggling or in survival mode—it’s hard for them to go back, to think of themselves as an employee for someone else.
Q: Walk us through the type of advice that you would give a self-employed individual at the various stages in their life. Decade by decade, if you were sitting down with a new potential client, what would you be advising them at that particular stage? Let me start off with a millennial customer. Someone you are meeting with for the very first time. You are getting their personality profile together and you’re advising them what to do in their 20s, if they expect to be self-employed their whole career. Focusing on that age bracket, what would your advice be?
Louis Barajas: At that point what I’m doing is guiding them through the entire process—all the core functions— of what you have to do to run a business. Again, we’ll go through one area of marketing, one area of HR, if you’re going to have to hire people, etc. But then we also get to the point of finances, internally from the business and externally for their own personal finances.
At that point a major core function I want to focus on is an area of finance within their own business – the financial statements; making sure that they have the proper bookkeeping and they’re recording how much money they’re making and what their liabilities will be for taxes. I will tell you that the biggest problem at the beginning with most entrepreneurs where they do get into trouble is in the area of taxes.
So we take that into account and show them how a retirement plan will help them minimize their tax liability. Entrepreneurs hate paying taxes. They hate it. They hate making quarterly payments. You can show them how having a retirement plan in place is another way to help toward their future goals, but also minimizes their current taxes.
Q: So now we’re talking about the client in their 30s. What are you advising them at that phase?
Louis Barajas: In their 20s clients almost feel invincible. They can overcome any hurdles. Once they hit 30 reality starts to set in, but they still have this mindset that still have a lot of time. One of the things that I start showing them is that they can build wealth one of two ways. They can build value in their company as the owner and that wealth is caused by creating equity in the company. Or they are able to create wealth by creating a certain level of income in the business. But they are going to have to put that money away into some sort of investment and the best investment to shelter money from taxes is a retirement plan.
Q: Now, what about a client who is in their 40s?
Louis Barajas: People who are in their 40s are kind of in the same status as people in their 30s, but now another decade has gone by. What I do is go back with them and take a look at the prior 10 years. I say, ‘ok, where did you think you would be by now, and are you where you thought you would be?’ I will tell you that 90% of people aren’t where they thought they would be.
Q: Are they usually better off or not as well off?
Louis Barajas: They’re always going to be better off. The problem is that they’re not where they thought they would be in the sense that they haven’t saved enough. They realize that life has a lot of twists and turns. Here’s another problem with entrepreneurs. I think that the divorce rate is America is about 51%, and I’ve seen as high as 57%. I have not seen that number extrapolated for entrepreneurs. But I will tell you that — and I have worked with so many entrepreneurs –the number is like 7 out of 10 entrepreneurs have already been through a divorce by the time they are in their 40s.
Q: No doubt this is largely due to the business owning them as opposed to them owning the business.
Louis Barajas: Exactly right. So what happens is that a lot of the entrepreneurs often give up a lot of the personal stuff that they have—they give the ex-spouse the house because they want to retain the business. They make trade-offs. Sometimes for a lot of people in their 40s they’re already in their second business. They’ve already gone through one, maybe even a bankruptcy, but now they’re in their second business or third business, and what took them 10 years to do they can rebuild very quickly.
Q: How about the client now in their 50s?
Louis Barajas: Actually, it’s not even in their 50s. Once they get to 5-0. That number 5-0 is just kind of a wake-up call to a lot of people. They say, ‘oh my god, what happened to the last 25 years or 20 years. It went by so fast.’ Most of them have kids now in their teens or in college, they have a lot of obligations. Their parents are now in their mid-70s. They also now don’t see themselves as invincible. They wake up and their bodies hurt. They can’t put in the same number of hours they could when they were in their 20s or 30s. But they have a lot of wisdom now. They can see that retirement is much closer than they thought.
So now they hunker down and think, ‘ok, by this point I thought my company would be worth so much.’ Let’s say they could sell their company for a certain amount of money. How long would that money last? So now we’re looking at ways to create retirement plans that will allow them to put more money away then they were doing before. In the past maybe they were using simple plans, simple IRAs for their company. Now they’ve moved into the 401(k). Maybe they’re thinking about adding a profit sharing plan. They want to shelter more money. Many of them don’t have as many personal obligations, so they can put more money away in to a retirement plan.
Q: Does the average self-employed individual work at age 62, age 65, age 67, the traditional retirement ages as their target as well?
Louis Barajas: For a lot of people I talk to, retirement is not really in their vocabulary. They’re going to do what they love to do until they can’t do it anymore. Some of them — even though at age 69 ½ you can tap into your retirement plan without a lot of the penalties — they’re not using the money and by that time they have their homes paid off and have accumulated a certain level of wealth, they’re still working part time, they have figured out a way to bring in people to help them run their businesses, and they’re not there five days a week or hours a week anymore. They may be there a couple of days a week, they’re traveling more, but they’re still earning some level of income.
Q: What would be your advice be to that individual? If they were going to stay working to some degree, would you advise them to delay receiving retirement benefits?
Louis Barajas: I would advise them to wait as long as they can to maximize their benefits. If you don’t need the money right away it’s good to wait. But it depends on a lot of things.
Q: In wrapping up, is there anything else we should explore?
Louis Barajas: What they need to do through this whole process is to think about their employees. Over the years some entrepreneurs will have employees that will help them for years — 15, 20, 25 years. I’ve had people come to me who had people work for them for 25 years that never had a retirement plan. And all of them have some form of guilt.
That’s when I have said to them, ‘what’s going to happen to Joe who has been working with you for 25 years but does not have enough money to buy your company if you retire? He has had no retirement plan, and has put no money away.’
You have to take a look at the fact that your employees are going to get older and the ones that are really going to stick with you for a long time need to be taken care of at some point. Even if you don’t have the money to put money into a retirement plan for yourself, you should really create something for them.