The Two Secrets to a Successful Small Business Retirement
Many small business owners are so committed to growing and driving money back into their company that they really haven’t given much thought to retirement. That is a mistake. Like so much else in business, owners need a plan — a strategy — to prepare properly for retirement.
I think it’s natural for go-getters to assume that they are going to continue working through their retirement. However, is that really a strategy you want to lock yourself into? A little planning now will give you the financial flexibility you need to retire if you later decide you want to, or need to. People are often forced to retire because of health reasons — a recent survey showed that only 45 percent of Americans retired when they planned. The majority of the early retirees did so involuntarily.
So, to start building your retirement strategy, my first question to you is, “What does retirement look like to you?” My second question is, “Do you have a succession plan in place?”
Having a succession plan is the first big secret to a successful retirement. A lot of business owners think their business is their retirement plan. They plan to sell their business, and the money from that sale will fund their retirement. The hard fact is that only three percent of entrepreneurs plan to acquire an existing business, so it’s often hard to find a buyer for an existing business.
Moreover, only 25 percent of small business owners have a formal succession plan in place. You don’t want to be in that 75 percent of business owners who haven’t thought about who takes over the business. Have a potential buyer on standby, with an agreement in writing, with a solid understanding of what the business is worth. If you want to use your business as a source of income during retirement, you need to have a specific plan in place and take concrete steps to make it happen.
The second secret to small business retirement: You need an actual retirement plan, one where you save a portion of your income, tax free, for your future retirement. There are three main types of employer-sponsored plans: SIMPLE IRA, SEP IRA and ERISA qualified plans.
- A SIMPLE IRA (Savings Incentive Match Plan) offers small employers a simplified way to provide a retirement plan. Employees may choose to make salary deferral contributions, and the employer matches the contribution, dollar for dollar up to three percent of compensation. Many business owners choose to offer a SIMPLE IRA. Plan administration is minimal, and the owner can max out their own contributions without having to worry if their employees are participating or not.
- The second type of retirement plan available to business owners is a SEP IRA (Simplified Employee Pension). The big selling feature of the SEP IRAs is the potential contribution — you can max out at 25 percent of pay up to $53,000 for 2015. This is a significant amount of money, but the catch is that the business owner must contribute this same percentage of compensation for all the firm’s workers. As a result, SEP IRAs are most popular for sole proprietors or in firms where there are just a few employees. If the business owner really wants to build up contributions quickly, a SEP can work very well.
- Small business owners can also consider an ERISA qualified plan — a 401(k) plan or a defined benefit plan. Those plans offer the option of adding life insurance into the plan as an investment option. Why would you want to add life insurance in your retirement plan? First, you get a tax deduction for the business. Second, it completes the retirement contributions, using the death benefit to ensure an adequate retirement income for the surviving spouse. You can only get that through life insurance, and it’s just part of the portfolio for either a 401(k) plan or a defined benefit plan. You can put up to 50 percent of the contributions into a life insurance policy, if it’s a whole life policy or 25 percent of plan contributions if it’s a term or universal life policy.
Penn Mutual has a number of great small business resources available to help you plan for retirement and get information on succession planning. First, there’s a very good calculator tool for self-employed retirement plans on our website. You put in your net profit from your Schedule C, a few other bits of information, and it outlines what your maximum contribution can be under each of the three options (SIMPLE, SEP, or 401(k)). We also have a new brochure available, Focus on Retirement Planning for Business Owners, which you can get from your Penn Mutual financial professional. It gives an excellent overview of the retirement challenges and opportunities for a small business owner. I will be blogging about many of these topics in future posts, but you can get a jump start by asking your financial professional for the brochure.