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Retirement Planning For Business Owners



This Blog Post is taken from the Financial Wealth and Health Podcast Episode #5: Retirement 101


“Retirement is wonderful if you have two essentials – much to live on and much to live for.” – Author Unknown


I think there is quite a bit of truth to this quote. While it is very very important to have enough money saved for retirement, it is also extremely important to still have passions and love for life in retirement. Having abundance financially and purposefully in retirement is crucial to a happy and fulfilling retirement.


To start off this blog post, I want to ask you: What is your retirement plan? If you’re a business owner reading this, then your answer may be more on the complex side. But even if you’re not a business owner, it is still extremely important to ask yourself this question!


While this blog post is geared toward business owners, I still think non-business owners should read this post, as many aspects of it can be applied to all retirement journeys.


Let’s get back to the business owner’s retirement situation.


For many business owners, their retirement plan is tied up in their business, selling it or continuing to have an ownership share. According to the Exit Planning Institute, almost 80% of businesses will never sell (2022). I think that most businesses don’t sell because not enough preparation has been put into the process.


But before we go much further into this topic, I want to look at how much savings most people have for retirement. For people that don’t own a business, where are they at with their savings?


It’s good to see the baseline reality.

The average 401k balance for people ages 45 - 54 is $161,079. The average 401k balance for people ages 55 - 64 is $232,379. This information is from PersonalCapital (2022).


While this may not sound like a lot of retirement savings, we have to remember that during COVID, many people either stopped putting money into their retirement funds or they chose to take money out prematurely. Many people right now are trying to get back on their feet with retirement to work toward having freedom and flexibility in this stage of life.


Okay, so we know where people are at right now with retirement savings, but where should they be?


This is what I call "starting at the end goal". I believe that one of the best ways to start planning for retirement is to start at the end goal to figure out how much you want to spend in retirement when you get to that point.


Once you know how much you want to spend each year, you can work backwards and figure out approximately how much you should be saving right now!


This information I am about to share is applicable to both people who are business owners and for people who are not business owners.


To start at the end point in the retirement planning process, I will share two numbers with you: 80% and 4%

The 80% number is the spending number. According to Fidelity, your retirement expenses will be about 55% to 80% of your pre-retirement income. For example: If you and your spouse make $100,000 together pre-retirement, you will spend about $55,000 to $80,000 a year.


Let’s look at the number 4%. This number is the withdrawal number. Every year in retirement, you should withdraw about 4% of your retirement savings. This number has been debated if 4% is actually accurate. Should is be higher or lower? But for many years, the recommended withdrawal number has been about 4%. For example: If your retirement savings is $1,500,000, you will probably spend about $60,000 a year.


To paint the picture further, according to USAToday in 2021, the average retired American spends a little over $50,000 a year, which is a little over $4,000 a month.


These numbers may sound a little bit overwhelming, so another way you can look at how much you should have saved for retirement is to keep it simple and take a look at how much you're spending right now as a working person. Or, think about the ideal salary you want to make by the time you are in your late 50’s or early 60’s.


Do you think you’ll want to spend the same amount when you're retired? Do you want to spend less or more? What parts of your life will change when you're retired?

Will you be downsizing your home and paying off your mortgage? Will you be going on more trips? Will you be helping fund your grandchildren's education?


Understanding how much you want to spend each year in retirement can help you figure out how much you need to save right now while you are still working.


Once you figure out how much you want to spend each month in retirement, it’s time to do some math. This is where we start working backwards to figure out approximately you should start to save today!


Whether you are a business owner or whether you work for someone, this “math” step is so important.


Now, what I do with my clients when we’re trying to figure out how much to save for retirement is to input many different numbers into a special retirement calculator that I’ve created. From a simple point of view, I have a five step process I use when I run my retirement calculator. The basic steps are shown below:


Step #1: We calculate what monthly income you need in retirement.

This will change with how much money you will receive from social security as well as how much money you may receive from the sale of a business. But we will talk about this more later.


Step #2: We also take into account how much your monthly spending in retirement may grow with inflation.

Spending $4,000 a month in today’s dollars is very different than spending $4,000 a month in 40 years. So our calculator takes that factor into effect, as well.


Step #3: We calculate the return on investment vs. the inflation rate.

Step #4: We calculate how many years you have until you retire and how many years you plan on being retired.


Step #4: We take into account what you currently have saved in your retirement funds.

Perhaps you have a 401k at work or a Roth IRA that you have already created and you want to know how much more to save each month to these accounts.


Step #5: Finally, we run various time value of money calculations, and calculate how much you need to save each month until you retire.

Through this process, I hope you can see how starting with the end goal of thinking about what you want your retirement to look like greatly helps you know how much to save.


Of course, all of these numbers that we use in our calculations are approximations and are not exact. Life throws a lot of curveballs that we don’t expect. But we like to still have a plan in place and then adjust the plan as the curveballs come!


If you would like to learn more about what your retirement savings should look like, feel free to reach out to me through my LinkedIn, my contact page on my website, or through my email. I would be more than happy to help guide you in your personal retirement numbers.


But how does your business play a role in your retirement savings plan?

Well, this can involve a business owner selling their business or continuing to have an ownership share in the business. A business owner can sell a business and receive a large chunk of money up front and then invest it to let it grow, taking money out periodically for retirement.


Or, perhaps the business owner receives payments for the business every month through a purchase plan or partial ownership share. Either way, a business owner can use his/her business as a source of income in retirement.


As a disclaimer, I’m not an attorney so I can’t share specifics about business valuations and sales, but I am just giving general examples to show how business owners can use the sale of their business as a way to create retirement income.


So what are some practical actions that business owners can do to prepare for retirement?

#1: Figure out what you want retirement to look like: When will you retire? How much do you want to spend in retirement?


#2: Decide if your retirement savings will come from a retirement plan, a sale of a business, or both? How much will you receive from your sale of your business? How much have you already saved in your retirement account?


#3: If your retirement is depending on the sale of the business, prepare now: Know your numbers, prepare your team and customers far in advance, have systems in place to pass on, have a valuation and a purchase plan set up (the purchase plan can help offer you income in retirement).


If you know that your business may or may not provide retirement income to you, but you still want to save money into a retirement account, you may be wondering what options there are for small business owners. Well, there are actually quite a few options!


However, many business owners aren’t taking part in the retirement plans that they offer to their employees! According to the SBA, small business owners over the age of 50 are less likely to have well-funded retirement plans than their employees (Forbes, 2019).


Shoutout to all business owners: if you offer a retirement plan for your employees, make sure that you take part in it, as well, if you can (there may be some applicable stipulations or rules that you should know about before you participate).


Today, we will be talking about some of the most common retirement plans for business owners: a Simple IRA, a SEP IRA, a Solo 401k, and a Roth or Traditional IRA.


First, let’s discuss the Simple IRA.

The employee contribution limit for this type of account is $14,000. Employer contributions for this type of retirement plan are mandatory and can follow one of two methods. The first method is for employers to match up to 3% of an employee’s salary (if the employee is also contributing). The second method is for employers to contribute up to 2% of the employee’s salary, even if the employee is not contributing, up to a salary of $305,000. A Simple IRA is a great resource for business owners to use to retire on behalf of themselves as well as helping their employees save for retirement. For more information about Simple IRA’s, check out this article from NerdWallet.


The second plan we’ll dive into is the SEP IRA.

The contribution limit for this is 25% of compensation or $61,000 in 2022. With a SEP IRA, you can still contribute to Roth and/or Traditional IRA, but income limits may still apply. A SEP IRA is a great tool to use if you are the only person in your business, but it is also a great tool if you want to offer a benefit to your employees. Just be cautioned that whatever percentage you contribute for your retirement plan, you must contribute that amount for your employee. For example, if you want to contribute 25% of your salary into the plan, you must contribute 25% of all of your employees’ salaries into the plan, as well. For more information about SEP IRA’s, please check out this article from Investopedia.


The next retirement plan that will be discussed is the Solo 401k.

This plan is designed for business owners who don’t have employees. Just like the SEP IRA, the contribution limit for this plan is also 25% of your salary up to $61,000 in 2022. This amount is broken down into the two different roles that a solo business owner falls into: contributions from the role of the employer and contributions from the role of the employee. As the employee role, the business owner can contribute up to $20,500 in 2022 or 100% of his/her salary, whichever amount is less. The number is increased when the business owner is 50 years old or older. As the employer, the business owner can make an additional profit-sharing contribution of up to 25% of compensation, also known as the net self-employment income. This number can be found by finding the net profit of the business and subtracting half of the self-employment tax as well as subtracting the contributions that were made as the employee role. The 25% limit is maxed at a salary of $305,000. The total amount that the business owner can contribute (as both the employee and employer) is $61,000. For more information, visit this helpful article from NerdWallet.


Finally, we have the standard Traditional IRA and Roth IRA.

The limits for this are $6,000 a year ($7,000 if you are 50 or older), and income limits do apply in different ways. IRA stands for Individual Retirement Account. You can open one up without your employer. It is in your control.


With a traditional IRA, you don’t have to pay taxes on this money. Why? Well, you get to deduct your contributions from your taxable income.


An Investopedia article explains, “With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later while Roth IRAs allow you to pay taxes on contributions now and get tax-free withdrawals later.”


For the Roth IRA, you are taxed on the money you put in, but when you take it out, there is no tax! Woohoo!


When it comes to a ROTH, the reason it’s called “after tax” is because you can’t deduct your contributions from your taxable income like you can with a traditional IRA. With a Roth IRA, your contributions will not change your taxable income.


To remember the difference, remember that the Roth Rocks! It really is good for young investors. This is because usually, the tax bracket you are in when you are in your 20’s is much lower than when you are in your 60’s.


So, you may be wondering if you should put money into a ROTH IRA or a Traditional IRA. How do you know which one to do?

The main question you need to ask yourself is if your tax rate will be higher in the future. For most people, they will be taking money out of these accounts at 59.5 years old. In certain situations, you can take money out without the penalty. But most of the time, people wait until age 59.5.


If you think between now and when you are 59.5 years old that your tax rate will go up, then you probably want to invest in a Roth IRA because you are investing at your tax rate right now. Suppose that your tax rate is at 12% right now and when you retire, your tax rate is at 22% or 24%. You’ll want to be paying taxes at the lower rate right now.


On the flip side, however, if you think that your tax rate will either stay the same or go down, you will probably want to invest into a traditional IRA so that you can take advantage of the tax savings now since your contributions will be tax deductible.


The bottom line is that you just need to decide if you want tax savings now or later? And at which time you will get the most savings.

If you are a business owner and you are wanting to create a retirement plan, please reach out to us! We want to help guide you along your financial path. We hope you enjoyed this blog post!


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Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.



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