Retirement Planning for Business Owners
For a lot of employees, saving for retirement may be as simple as opting to participate in their employer’s 401(k) plan and/or opening an individual retirement account (IRA) for some extra personal savings.
But what about when you are the business owner? When you own a business, planning for retirement requires forethought and strategy, skills that most independent business owners have acquired. When a business owner is planning for retirement, it can be challenging to decide what route to take. Along with all the options for retirement accounts, there’s also planning for the business itself. Who will run the business after you retire? Additionally, your estate plan must integrate into your retirement and business transition strategy.
Owners of businesses want to make sure they will have enough money for their retirement. They recognize the value of their businesses and are often tempted to reinvest everything into their business with the understanding that when they sell their business, they will make enough money for their retirement. While this may sometimes be true, depending on the sale of your business for your retirement is not the best retirement plan.
Retirement Accounts for Business Owners
Rather than placing all your eggs in one basket, it makes sense to have backup strategies in place or a Plan B, C and so on. There are many options when it comes to retirement accounts available to business owners. Although the number of options can make things confusing, an estate planning attorney may have some great recommendations of financial planners or financial advisors that are familiar with retirement planning options and can quickly make recommendations for you. Having a financial advisor and a CPA or tax accountant on your financial planning team is a common way to build a strong retirement plan.
With respect to retirement funding options, you may consider opening a 401(k), SEP-IRA, SIMPLE, or pension plan. This can reduce your income taxes now, while simultaneously placing some of your wealth outside your business. From a financial perspective, these accounts are tax-deferred, so the investment growth avoids taxation until you retire, which greatly boosts returns.
Your plan, or the plan that best fits your circumstances, 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. You must consider how generous you’ll be with employees because the law requires most tax-deferred plans to be “fair” to all employees.
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 harder work and loyalty from the employees. It may be a good idea to educate your employees on how retirement plans and retirement savings work, so they are aware of your generosity and understand some of the decisions that a business owner makes.
Depending on how many employees you have, you may 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.
As a business owner planning for retirement, you likely have a great deal of control over your health insurance decisions. If you’re relatively young and healthy or otherwise an infrequent user of health care services, consider using a high deductible health plan (HDHP) and a health savings account (HSA) to add additional money to your savings. These plans let you set aside money in the HSA which can be invested in a manner similar to IRAs. At any time after you setup the account, you can withdraw your contributions and earnings, tax-free, to pay for qualified medical expenses. And, after you turn 65, the money can be used for whatever purpose you want, although income tax will need to be paid on the distributions.
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.
However, other businesses are may be different like family businesses where children or grandchildren will one day become owners. Like their counterparts who will sell their businesses, 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 gradually buy-out the owner, if the owner needs or wants to obtain a portion of the retirement nest egg from the business. One of these options is known as a buy-sell agreement.
The Importance of Estate Planning
Regardless of which retirement accounts (401(k), SEP, SIMPLE, IRAs, HSAs) you select as a business owner planning for retirement, 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 one of your children or maybe you've already spoken to a third-party buyer).
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
Here at Durfee Law Group, we value the strength that comes from working together with other professionals through a team approach to provide the most complete and integrated retirement plan for your needs. Please let us work with your business advisors or consultants, your tax advisor, and your financial advisor to develop a comprehensive retirement, business transition, and estate planning strategy. When we work collaboratively, we can focus on setting aside assets for retirement and tax savings to help free up time for you to do what you're best at--running a solid business.
Give us a call today at 480.324.8000. We would love to help you craft a retirement, business transition, and estate planning strategy.
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