4 Ways Business Owners Can Catch Up for Retirement in a Hurry
By Bryan Lee, CFP®, MBA
Owning a business is a lot like parenthood. In fact, research shows that brain activity when founders look at their own companies is similar to when parents look at their children. (1) It makes sense. Just like with a child, you nurture your business to grow, succeed, and benefit your customers and clients, your employees, and society.
This attachment creates an emotional investment that makes it challenging to find a balance between prioritizing personal finances and your business. For instance, business owners commonly face the struggle of creating a plan to convert their successful business into long-lasting personal wealth—namely retirement savings. Many small business owners invest personal savings into their business, and because they often don’t even plan to retire (at least not fully), they never create a retirement savings plan. (2) This can result in a dire situation as they draw closer to retirement without a nest egg.
Although you’ve become accustomed to putting your business’s needs above your own (much like a parent prioritizing their child’s needs), it’s crucial to remember one thing: your retirement is just as important as the success of your business! Here are four ways you can catch up for retirement in a hurry.
1. Find the Right Plan for You
Unfortunately, as a business owner, you probably don’t have an employer-sponsored 401(k) account with matching contributions at your fingertips unless you are also working elsewhere. That doesn’t mean you are out of luck when it comes to building a nest egg. Here are some savings options to consider.
Traditional IRA
A traditional IRA is similar to a 401(k) in that you can contribute pre-tax dollars to an investment account that grows tax-deferred. If you or your spouse can participate in a retirement plan, you may not be able to make deductible contributions to an IRA depending on your adjusted gross income (AGI). For 2021 and 2022, you can contribute up to $6,000, or if you’re over age 50, a total of $7,000.
Roth IRA
With a Roth IRA, your contributions are not tax-deductible like traditional IRAs. However, your earnings grow tax-deferred and your withdrawals are tax-exempt (subject to IRS guidelines). Like a traditional IRA, for both 2021 and 2022, you can contribute up to $6,000, or if you’re over age 50, a total of $7,000. However, one caveat to the Roth is that there are income restrictions. (3)
SEP IRA
A SEP IRA, also known as a Simplified Employee Pension, is an IRA similar to a traditional IRA. As an employer of yourself, you can make contributions on your behalf for your retirement. You can set up a SEP IRA and contribute 25% of wages if you are an S Corporation or 20% of your net self-employed income if your business is an LLC, a partnership, or a sole proprietor. These contributions are limited to $58,000 per year for 2021 and $61,000 for 2022. (4) The major drawback of the SEP is that you have to make the same contribution to other employees.
Solo 401(k)
A solo 401(k) is similar to a traditional 401(k) you’d contribute to as an employee. Funds invested within a solo 401(k) plan grow on a tax-deferred basis (a Roth solo 401(k) may be available as well, depending on the chosen account custodian). The powerful feature of this plan is that you can contribute in two separate capacities: as an employee and as an employer. Wearing your employee hat, you can defer up to $19,500 or $26,000 if age 50 or older (these numbers go up to $20,500 and $27,000 for 2022). (5) As the employer, you can also contribute up to 20% of net self-employment income (or 25% of wages) as defined by the plan. Combined, for 2021 you can contribute up to $64,500 if you’re over the age of 50 ($67,500 for 2022). (6)
Adding a Defined Benefit Plan
In order to save more than you can in an IRA or 401(k), you can set up a defined benefit plan. These plans have much higher tax-advantaged contribution limits and can be designed to fit the needs of almost any business. The older the owner and the higher the compensation they have (up to IRS compensation limits), the larger the contribution allowed to the owner. Defined Benefit Plans are not subject to the 25% employer deduction or participant contribution limitations. Be aware, these plans can be expensive to set up and maintain so they are usually only beneficial to those subject to the highest tax bracket and have predictable cash flow to meet the funding requirements.
Ultimately, everyone’s situation is unique, so there’s no one right solution. However, for many people, it makes sense to contribute pre-tax and post-tax dollars to several different accounts. For example, along with a solo 401(k), you may also want to contribute to an IRA and a Defined Benefit Plan.2. Banish Debt
Conventional wisdom is that the less debt you have when you enter retirement, the better. Whether it’s personal debt in the form of credit cards, car loans, or a mortgage, or business debt in the form of bank loans or equipment purchases, reducing your debt before retiring will lower your monthly expenses and enable your savings to grow and last longer. However, carrying low-interest debt, such as a fixed-rate mortgage, into retirement could actually yield a better outcome than paying it down. Whether it’s optimal to pay it off just depends on whether those funds could earn a higher rate of return through investment. Review all current debts you face and compare interest rates and balances. This can help you decide which to pay off first. Working with a fiduciary financial planner who takes a holistic approach can help you decide what’s best for your situation, as the decision to pay off debt is not a purely financial one.
3. Look Ahead to the Future
Do you have an exit plan? Even if you are just in the beginning stages of your business, it’s imperative to have a plan for the future of your company because if it succeeds, it will likely become one of your largest assets. Around 78% of small business owners plan to sell their businesses to fund their retirement, with the sale profits funding 60-100% of their retirement needs. (7) If you are heavily relying on the sale or succession of your business to take care of your future financial needs, it’s critical that you start thinking about how and when you may want to leave your business and what you can do now to prepare so you receive the highest price possible. Having a strategic transition plan will make your company more appealing to buyers who want assurance that it will continue to thrive without you. Even if you’re passing the business on to family members, you need a plan in place to ensure that it continues to prosper and all family members are treated equally. Equally important is having a plan for retirement that incorporates the expected proceeds or income stream from the sale of your business.
4. Partner With a Professional
Just like parenthood, owning a business is a demanding (albeit rewarding) journey that complicates your life and finances. In addition to saving for retirement and taking care of your family, you may also have employees and tax considerations to think about. Given your unique situation, you would benefit from working with someone who specializes in serving business owners and who can bring an experienced, objective perspective to the table.
That’s where the Strategic Financial Planning team comes in! Specializing in holistic financial planning and wealth management for small business owners and tailoring our services to address clients’ specific financial needs, we pride ourselves on our unique client-first approach and process to help you get the most out of life.
Call (972) 403-1234 or contact us online to set up a complimentary get-acquainted meeting so we can see if we are a good fit to help you catch up for retirement in a hurry!
About Bryan
Bryan Lee is the founder and president of Strategic Financial Planning, Inc., an independent, fee-only financial advisory firm. With more than 27 years of industry experience, Bryan uses a unique client-first financial life planning approach and process to help his clients get the most out of life. Bryan earned his Bachelor of Business Administration in finance and his MBA in international finance from the University of North Texas. He is also a CERTIFIED FINANCIAL PLANNER™ professional.
Bryan is actively involved in his community and industry and has served on the boards of several associations and charities, including the Dallas/Fort Worth chapter of the Financial Planning Association, the National Association of Personal Financial Advisors, Family Services of Plano, the CITY House, and the Journal of Financial Planning. Bryan has been featured in local and national media, including The Wall Street Journal, Investor’s Business Daily, CNNfn, USA Today, SmartMoney, Kiplinger’s Personal Finance, Financial Planning Magazine, The Dallas Morning News, and Dow Jones Newswires. And, he has been recognized as a Five Star Wealth Manager and one of Dallas’s Best Financial Planners in D Magazine every year since its inception and recently as a Top Wealth Manager. To learn more about Bryan, connect with him on LinkedIn._________________
(1) https://www.forbes.com/sites/rhettpower/2019/06/16/how-parenthood-has-made-these-8-entrepreneurs-better-business-owners/?sh=291971427012
(2) https://www.investopedia.com/articles/personal-finance/120314/top-retirement-strategies-small-business-owners.asp
(3) https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2022
(4) https://www.irs.gov/retirement-plans/retirement-plans-for-self-employed-people#:~:text=Simplified%20Employee%20Pension%20(SEP),2020%20and%20%2456%2C000%20for%202019
(5) https://www.irs.gov/retirement-plans/one-participant-401k-plans#:~:text=Elective%20deferrals%20up%20to%20100,age%2050%20or%20over%3B%20plus
(6) https://www.forbes.com/advisor/retirement/401k-contribution-limits/
(7) https://www.pnc.com/insights/small-business/business-planning/selling-business-to-fund-retirement.html#:~:text=Few%20actually%20use%20it%20to,100%20percent%20of%20their%20retirement