For many employees, saving for retirement is usually a matter of simply participating in their employer’s 401(k) plan and perhaps opening an IRA for some extra savings.
But, when you’re the owner of a business, planning for retirement requires proactive, strategic thinking. In addition to the dizzying array of choices for retirement accounts, business owners must also consider planning for the business itself. Who will run the business after your retirement? Your estate plan must integrate into your retirement and business transition strategy.
Like anyone else, owners of businesses want to make sure they will have enough money in retirement. Business owners also recognize the value of their businesses, which tempts them to reinvest everything into the enterprise, thinking that will be their “retirement plan.” However, this might be a mistake.
Retirement Accounts for Business Owners
Rather than placing all your eggs in one basket, it makes sense to have some secondary strategies in place. There are many retirement account options open to business owners. Although the number of options can make things confusing, a tax and financial professional can often quickly make a recommendation for you.
For example, you may consider opening a 401(k), SEP-IRA, SIMPLE, or pension plan. This can reduce your income taxes now, while simultaneously transferring some of your wealth outside your business. Many of these accounts are tax-deferred, so the investment growth avoids taxation until you retire, greatly boosting returns. The “best” plan really depends on how much income your business earns, how stable your earnings are, how many employees you have, and how generous you want to be with those employees. The law requires most tax-deferred plans to be “fair” to all employees, so it’s important to consider this last part carefully. For example, you can’t open a pension or 401(k) for yourself only and exclude all of your full-time employees. When making this decision, consider that many employees value being able to save for their retirement, and your generosity may be repaid with loyalty from your employees.
Depending on how many employees you have, you may even consider “self-directed” investment options, which can allow you to invest some or all of your retirement funds into “alternative” investments, such as precious metals, private lending arrangements, real estate, or other closely held businesses. These self-directed accounts are not for everyone, but for the right person, they open up a wide world of investment opportunities. The tax rules surrounding self-directed tax-deferred accounts are very complex and penalties can be incredibly high. So, if you choose to do self-directed investments, always work with a qualified tax advisor.
Outside of your business, you can likely contribute to an IRA or a Roth IRA. This can allow you to add more money to your retirement basket, especially if you’ve maximized your 401(k), SEP, or SIMPLE plan. Like the other tax-deferred accounts, self-directed IRAs are also an option, opening up a broad world of investment options.
Selling or Transferring the Business
Many business owners dream of a financially lucrative “exit” when a business is sold, taken public, or otherwise transferred at a significant profit for the owner. This does not happen by accident – a business owner must first create and sustain a profitable enterprise that can be sold. Then, legal and tax strategies must be coordinated to minimize the burdensome hit of taxes and avoid the common legal risks that can happen when businesses are sold. When a business is sold, the net proceeds can form a significant component of the owner’s retirement. When supplemented by one or more of the retirement accounts discussed above, this can be a great outcome for a business owner.
Some businesses are “family” businesses where children or grandchildren will one day become owners. These business owners must also focus on creating and sustaining a profitable enterprise, but the source of retirement money is a little less clear. In these cases, clearly thinking through the transition plan to the next generation is essential. Although the business can be given to the next generation through a trust or outright, there are also transition options to allow for children, grandchildren, or even employees to buy-out the owner over time if the owner needs or wants to obtain a portion of the retirement nest egg from the business.
The Importance of Estate Planning
Regardless of which retirement accounts you select, it is wise to integrate them into your estate planning. You’ve probably already considered who you want to take over your business after you retire (perhaps a son or daughter or a sale to a third party). For your retirement accounts, an IRA trust is a special trust designed to maximize the financial benefit, minimize the income tax burden, and provide robust asset protection for your family. These trusts integrate with the rest of your comprehensive estate plan to fully protect your family, provide privacy, all while minimizing taxes and costs.
Leverage the Team Approach
Work with your attorneys, your business advisors or consultants, your tax advisor, and your financial advisor to develop a comprehensive retirement, business transition, and estate planning strategy. When you put this team to work collaboratively, they can focus on setting aside assets for retirement, saving as much tax possible, while freeing you to do what you do best – build your business!