Did you know that only one in four business owners has a retirement plan, and they face other challenges prohibiting them from saving?
Planning typically is much easier for retirees when they knew the amount of income they’ll receive every month and then can budget accordingly. It’s pretty common for seniors to say they live on a “fixed income” because they received a guaranteed monthly pension and Social Security every month.
Certain workers also know they have a retirement plan to look forward to, thanks to benefits provided by their employer. However, only one in 10 private sector employees now participate in a traditional pension plan, also called a defined benefit plan, which guarantees a fixed monthly income when they retire.
About half of the rest of us participate in a defined contribution plan, like a 401k, which builds savings to draw from after retirement. Unlike a pension, it is not guaranteed and does not pay out every month for life. Instead, we are responsible for how much we invest and withdraw from the plan.
You may have seen articles debating the amount you need to save to have a comfortable retirement without running out of funds. Estimates range from 8-12 times your annual salary. However, according to the US government, the median amount saved by those aged 55-64 in 2022 was only $185,000. It will not be enough.
However, there is hope with some smart planning, so here are some tips to adequately fund your retirement if you own a business.
Know your tax rates
Many of us have heard over the years that business owners should pay themselves first. Many eager entrepreneurs rush to start a 401k plan without thinking it through because they believe it is the right thing to do.
If your tax rate is low, I suggest holding off on setting up a SEP IRA or 401k for your business because the taxes saved for contributing can be insignificant, and if you need to access the funds later, which can be expected if you are self-employed, the taxes and penalties for tapping your retirement plan savings could be excessive.
A good idea is to ask your accountant what “effective” and “marginal” tax rates you are paying, and if contributing to a plan will reduce your taxes.
Of course, setting aside savings for yourself and the business is still essential, but I recommend building up your emergency savings first with post-tax dollars if your tax rate is low.
Most financial advisers suggest that an emergency fund cover at least six months of operating expenses. Once you have the emergency funds set up for you and the business, check back in with your financial planner to see if it is time to set up a plan.
Learn about exit planning
One of the reasons that most business owners choose not to save is that they plan to sell their business as a primary source of retirement income.
After all, they put all of their resources into the company, but this can be risky. According to the business sale database BizBuySell, the median price for a small business is only $329,000, and only a third of owners with a company valued at $2.5 million or more can find a buyer.
You need additional planning to beat those odds and utilize your business as your primary retirement asset. Exit planning helps you prepare your business for sale and to maximize the sales price. You should start exit planning on day one if you own a business.
No matter how long you have been self-employed, I suggest creating a five-year exit strategy now. For several reasons, five years is the optimal number of years to execute the plan, and there are many books on how to increase sales and make your business run without your day-to-day involvement. Start working ON instead of IN your business.
There is no rule that you need to operate your current business until retirement age, and I have served as a consultant on several sales of companies valued in the tens of millions of dollars for sellers who were only in their forties.
Most of us struggle to let go of our creation. Our identity is tied to the success of our business. So, read this a couple of times: If you sell in five years and pocket the proceeds, your life is not over, you are not old, and you can still work. You can start another business, maybe in a new and fun location, or turn your focus to an idea that has been on your mind for some time.
On the other hand, there is no harm or foul if you decide in five years not to sell, except your business will have increased in value for eventual sale. Just start over with another five-year plan.
Calculate your EBITDA
The first step of your plan is to know the current value of your business. Most businesses sell using an agreed-upon multiple-times indicator of profitability, sometimes gross sales or cash flow, but usually, it is EBITDA (Earnings Before Income Taxes, Depreciation and Amortization).
The good news is that, according to the Value Price Index, median EBITDA sales multiples reached a high in the last quarter at 4.3. For example, if a business had an EBITDA of $100,000 and sold at a multiple of 4.3, the sale price would be $430,000. However, if a company sold at the same multiple, and its EBITDA was $500,000, the sale price would be $2,150,000!
Ask your accountant to help calculate your EBITDA. One of the goals of your five-year exit plan is to increase your sales and your EBITDA.
Of course, the multiple is just an estimate and starting point. Many other factors will determine the listing price for your business. Generally, a business broker will not charge for an initial consultation to discuss the possible asking price for your business.
If you own a business but do not want to rely entirely on the sale of the company to fund your retirement, there are several other solutions. Here are just a couple.
Buy your building
Purchasing the building(s) and land where your business is located can be a good investment. The SBA (Small Business Administration) helps with loans to buy commercial real estate. I have seen some owners sell their real property for more than their company. I have also seen owners sell the business but continue to rent the property for additional retirement income.
Set up your own pension
If you want the security of a fixed monthly pension, you can set up a defined benefit plan. We generally implement this type of plan when the business owner is over age 50, has reliable profits, and intends to keep the business until retirement age.
There are so many other tax savings and wealth-building opportunities for you to explore as a business owner. I hope this is a good start.
Michelle C. Herting is a CPA, an Accredited Business Valuator, and an Accredited Estate Planner. She specializes in succession planning, business valuations, and settling trusts.
