By Stephen Hassell, CFP®
Running a business can be rewarding both personally and financially, but it can also present you with unique challenges to managing your financial and life goals over time. In this article, we will explore three of the top personal finance challenges business owners face when planning their financial future.
Converting Your Business into Retirement Income
Most business owners know that one day they would like for work to be optional, and they would also like to capture some value for the business that they have built and grown over the years.
If you are entertaining the sale of your business to fund your longer-term financial goals, it likely will make sense to begin planning years in advance. This is especially so if you are planning an internal transition to another key member or members of your team.
You may be thinking that an outright sale to a third-party is the best way to go, but that’s not always the case. You may discover that engaging in an internal succession can maximize the value received for your business and grant you the enjoyment of seeing the business pass on to the next generation.
When internal successions are not an option, being closely in touch with your industry and valuations can be a great place to start. Understanding the drivers of growth and profitability in your business contributes to the desirability of a third party wishing to purchase that business in the future.
The bottom line here is to get at least a conservative understanding of what the value of your business is. Seek outside counsel in determining a value and making sure that you are following industry best practices. That way, you can help ensure you are building something that another person may want to purchase.
Understand Your Personal Cash Flow Needs
If you are like many of the business-owner clients we work with, you likely have greater clarity about what your business spends than you do about what you spend personally to run your household.
Many clients we work with get close to retirement and have no idea how much money they may need to live on when they stop working. For business owners, this reality can be further complicated by the blending of certain personal expenses into the budget for the company (vehicle expense, travel and entertainment, etc.).
Know that a key variable when trying to establish a workable financial plan is the amount of money you need once you step away from your business to meet your future financial needs. Below is a quick way to get close to what an appropriate baseline spending rate may be in retirement.
Current take-home pay (or draw) less taxes
Subtract debt payments that you don’t expect to continue in retirement
Subtract miscellaneous expenses you don’t expect to have in retirement (e.g., childcare)
Subtract current amount you may be putting in savings from your take-home pay
Add back any expenses that the company may pay for that you expect might continue in retirement (e.g., travel or vehicle expense)
What’s the bottom line? That’s probably a good place to start when thinking about your baseline living expenses. The figure you come up with may shock you, but getting to an accurate target can help you and your financial planner take the necessary steps to plan accordingly so that you are well situated for retirement.
It is our experience that most people want to maintain a similar lifestyle in retirement; therefore, this will get you close to that figure. From here, you can begin working to determine whether you are doing all you need to in order to provide that level of income. Working with a financial planner can help add the necessary clarity, strategy, and accountability to feel confident in the direction you’re headed.
Here is another tip to remain better organized (and you may already be doing it): Consider segmenting your business income into salary (for the role you perform as an employee in your own business) and profit distribution (additional earnings for being a business owner).
This framework can help you develop more consistent cash flow for personal planning and allow you to better gauge the true profitability of your business.
Diversifying Wealth Outside of Your Business
It is not uncommon that business owners put everything into making their company a success. While often necessary in the early stages of starting a business, it is important to consider the benefits of diversification as a part of a well-rounded wealth accumulation strategy.
Rather than funneling all profits back into the business, it may be sensible to diversify your assets into other investments. This may take the form of investment real estate, other businesses, or more traditional investments like stocks and bonds.
One of the best ways to begin diversifying your wealth accumulation strategy is to establish a qualified retirement plan for your business. Selecting the right plan is something that a financial planner can assist you in evaluating.
Qualified plans (like 401(k) plans) allow you as the business owner and other employees to set aside money with each paycheck and even receive a match or profit-sharing contribution. Depending on how the plan is designed, you may be able to contribute $57,000 or more to a plan that helps work toward some of your longer-range goals in retirement. These contributions also happen to be tax deductible in the year they are made, so you can build wealth and save on taxes at the same time.
If you are a small business owner without employees, then using a plan like a SEP-IRA for significant funding may be ideal. Work with your financial advisor to determine what makes the most sense, or schedule a 30-minute discovery call with one of our CERTIFIED FINANCIAL PLANNER™ (CFP®) professionals. Based in Houma, LA, our fiduciary financial planning firm has expertise in the needs of business owners.
Review this helpful retirement plan comparison chart to explore some of the available options.
Bringing It All Together
As a business owner, you have numerous obstacles and opportunities you face on an ongoing basis. For a well-rounded financial plan, consider taking to heart some of what’s been covered in this article.
As a rule, clarity early in the financial planning process can lead to better outcomes over time. Knowing what your business may be worth is an important step in deciding how much your financial plan may rely on this asset. Honing in on the cash flow you need once you stop working to live life the way you want is necessary to help fill in the gaps, with diversification strategies helping to supplement any income you may receive from the sale of your business.
Sorting through these things with a professional may be your next best step. If you work with a financial planner already, revisit your numbers and make sure that future business values are not the core of your plan. Make sure you are diversifying your wealth accumulation strategy.
Want to speak with a professional? Schedule a complimentary 30-minute discovery call with a fee-only financial advisor to discuss your financial situation.