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Retirement Planning for Business Owners

Nadira Deery, MSF, CFP®

Director of Financial Education

Last Updated
November 24, 2021
Headline Retirement Planning for Business Owners

Three tips to plan for your personal financial future while running your business

As a business owner, you’re busy with the day-to-day management of your business – taking care of employees, helping customers, working with vendors, etc. Plus, you’ve likely put a good percentage of your profits back into the company. You have a lot riding on your business, and it can be tempting to invest all your resources into making it a success. However, it’s vital to plan – not only for the future of your business, but also for your personal financial future. As difficult as it may be to imagine now, you will want to retire one day, and it’s important to start planning for that day as soon as possible. The following tips can help you get started.

1. Understand your needs in retirement

The first step is to estimate your monthly retirement cash needs. How do you plan to spend your time in retirement? Where will you live? Will you have more than one home? Do you plan to travel extensively? Your goals should serve as a starting point to give you an idea of how much you may need each month.

As a business owner, you likely have overlap between your personal and business finances. For example, you may drive a company car that you claim as a business expense but also use for your personal needs. You may reinvest a significant amount of profit back into the business rather than taking a salary. These are important factors to consider as you plan for retirement, as they will likely impact your monthly income needs.

2. Develop a retirement savings plan

As a business owner, saving for retirement isn’t quite as easy as automatically contributing to an employer-sponsored 401(k). You need to be a bit more strategic and intentional about your retirement savings. If you do not have access to an employer-sponsored retirement plan, consider establishing one (or several) of the following retirement savings vehicles.

Traditional IRA – A traditional IRA allows you to make contributions with pre-tax dollars. This means you can defer taxes while you are working and potentially in a higher tax bracket, then pay taxes on withdrawals when you are retired and (hopefully) in a lower tax bracket. For example, you make contributions to your traditional IRA when your business income puts you in the 32% tax bracket, then pay 12% in income taxes on any withdrawals in retirement. Of course, this strategy assumes your income will be lower when you retire than it is today. However, some business owners actually find themselves in higher tax brackets once they retire and begin taking a steady stream of income, so it’s important to understand your personal financial situation.

Roth IRA – Roth IRAs offer the benefit of tax-exempt growth. Because contributions to a Roth IRA are made with after-tax dollars, you don’t receive a tax deduction up front, but withdrawals in retirement are typically tax-free. This can be a huge benefit for business owners whose monthly income is expected to increase during retirement. It’s important to note that there are income limits imposed on Roth IRA contributions. Your wealth manager can help you determine if you are eligible to make Roth IRA contributions.

Simplified Employee Pension (SEP-IRA) – You may consider setting up a SEP-IRA to help yourself and your employees save for retirement. In 2021, a SEP-IRA allows small businesses owners to defer up to $58,000 (or 25% of an employee’s compensation) to retirement savings. Contributions can only be made to a SEP-IRA by you, the employer. To be eligible, an employee must be at least 21 years old, work full-time at the company, have worked in the business for three of the last five years and receive at least $650 in annual compensation.

Savings Incentive Match Plan for Employees (SIMPLE IRA) – A SIMPLE IRA is another retirement savings vehicle that can be used by both business owners and their employees. In contrast to a SEP-IRA (where the employer makes the contributions), employees are eligible to make tax-deductible contributions to the plan. As the employer, you can match up to 3% of an employee’s salary, or make nonelective contributions of 2%, to every eligible participant, regardless of their participation. The 2021 annual employee deferral limit to a SIMPLE IRA is $13,500. Those age 50 and older can make a catch-up contribution of $3,000, raising their annual deferral limit to $16,500. To be eligible, you must have no more than 100 employees. Each employee must have earned at least $5,000 in eligible compensation in any two previous calendar years (and be on track to earn at least $5,000 in the current year) in order to participate. As the employer, you can exclude employees who receive benefits from a union and can also choose less restrictive participation parameters.

3. Consider your exit plan

Your business may end up being your largest asset, which is why it’s important to understand its value and begin planning early for its eventual sale. How will you eventually exit your business? Will you sell it to an outside owner? Pass it on to a family member or key employee? Have a partner buy you out? Take time to consider all your options and how they may impact the eventual value of your business.

A good place to start is to gather the last five years of your company’s financial records for a valuation, along with any agreements you may have with partners. Your wealth manager can use these to help you evaluate your exit planning options.

At Creative Planning, we help navigate the unique challenges business owners face when planning for retirement and exiting their business. Our experienced professionals, including CERTIFIED FINANCIAL PLANNER™ practitioners, business valuation specialists, CPAs, insurance specialists and attorneys, work together to help ensure all aspects of your business and personal finances are well cared for. If you’d like help planning for your retirement, or for any other financial matter, please schedule a call.

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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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