Retirement Strategies: The Future is Now

By Craig Koop as featured in Cutting Edge

As any owner of a diecutting and diemaking company knows, running a small to medium-sized business is more than a full-time job.

Depending on the size and structure of the operation, the owner may serve as marketing director, chief salesperson, director of human resources and more. In this environment, successful owners soon learn that setting priorities is essential. Unfortunately, in their efforts to keep their business profitable today, many owners may neglect to plan for tomorrow.

The sad result is that when owners finally decide to retire, they may lack the resources to do so. Consequently, that fishing excursion to Cabo San Lucas, for example, may never materialize. Given these realities, small business owners need to bring the same enthusiasm to planning for their retirement as they do to carrying out the daily operations of their company. But how does the typical owner, who is already pressed for time, do this?
Make a commitment

The first step is to recognize retirement is as important as a career. In other words, owners need to make a conscious decision to make themselves a priority. Once this step has been taken, it’s important to ask some key questions such as: When do I want to retire? Do I want to sell my business, or pass it along to my family? What sort of lifestyle do I wish to lead in retirement? How much income will I need to fund that lifestyle? And, of course, where will the money come from? Asking and answering these questions helps set essential goals.

For most owners, the key concern is having enough money to maintain a comfortable lifestyle after retiring. The question then becomes, how do I get there? Unfortunately, because there are a variety of retirement vehicles, owners may feel overwhelmed and down with a tax attorney and a certified financial planner who can do an analysis of the client’s goals. Financial planning consultants can also help business owners consider factors such as company size and profitability to help them choose among a variety of investment options.
Choose the best plan

Planning for retirement depends on an individual’s goals and the size, structure and profitability of his business. Therefore, no single best retirement plan exists. The owner’s goal, then, should be to educate himself and discuss his situation with a financial advisor who can help him choose the plan or plans that best fit his needs and those of his company. Among the factors an employer should take into account are:

  • What is the maximum amount I can afford to invest?
  • What is the setup difficulty of different plans?
  • How difficult and expensive will the plan be to administer?
  • What are the tax advantages (or disadvantages) of various plans?
  • What commitment am I willing to make to the plan and to my employees?

After discussing these issues with a financial consultant, an individual can explore specific options.

Retirement strategies and options

Here are some possibilities:

1. Sell the business. One exit strategy is to sell the business and use that revenue for retirement. While this might seem like a logical solution, it brings with it a host of problems. Essentially, owners who adopt this strategy put all their retirement eggs into one basket. This is risky, since any company has the potential to fail or to decline in value by the time the owner wishes to sell it. In other cases, owners may overestimate the value of their business or wish to pass it along to their children – often at far less than fair market value. As a rule, then, financial consultants advise owners to examine options other than selling the business to fund their retirement. These options usually involve tax-deferred plans, such as 401(k)s, IRAs and SEPs.

2. Seek out tax-deferred vehicles. Many financial advisors consider tax-deferred mechanisms as the cornerstone of a sound retirement strategy. There are two main reasons for this. One is the “time-value-money” benefit, which means that by using a tax-deferred option an individual is able to invest money that would have otherwise been paid to the government in taxes. In other words, instead of investing $70 and paying $30 in taxes, an individual is able to invest the entire $100. This amount will grow faster and when extrapolated over time, the tax-deferred mechanism becomes an incredibly powerful investment tool. Consultants refer to the second reason as the “reduced tax rate benefit.” By deferring taxes until retirement, an individual will, in nearly all cases, be paying taxes on a reduced income and thus be in a lower tax bracket.

3. Implement 401(k) plans. Most consultants consider the various 401(k) plans to be an extremely effective retirement savings tool. These offer individuals the ability to set aside $15,500 a year tax free – and an additional $5,000 in “catch-up” contributions for those 50 or older. Unfortunately, small business owners tend to underutilize these plans, often due to misperceptions. For example, small-business owners may believe they do not have enough employees to make these plans worthwhile or that they cannot afford a company match.

4. Consider IRAs – Traditional and Roth. Both of these savings mechanisms provide for the tax-free accumulation of retirement income. In the traditional IRA, an individual is eligible to begin withdrawing his or her funds at age 59 ½. The investor may, however, wait until age 70 ½ to begin taking distributions. An advantage of the IRA is that it is simple to set up. A disadvantage, however, is that the contribution limits are quite low – currently $4,000 per year ($5,000 if the investor is 50 or older). For most individuals, this is far too little to fund a comfortable retirement.

While similar to the traditional formula in many ways, the Roth IRA differs significantly in that taxes are paid on income before the money is deposited into the Roth. This means that money deposited in the Roth grows tax-free. Additionally, when funds are withdrawn from the Roth, no taxes are due. Since none of the investment growth is ever subject to income tax, it increases net investment return.

5. SEP (Simplified Employee Pension) Plans. The SEP Plan is popular among small to medium-sized operations. In a SEP Plan the employer is solely responsible for contributing to IRA plans for his employees. The SEP is an attractive benefit that allows smaller companies to compete with larger firms for the most desirable workers. Another advantage of the SEP is that it is a simple plan to administer. In a 401(k) plan, for example, there are many administrative requirements and complexities that add to the administrative cost. Administrators of these types of plans may need to set up a separate trust, which increases administrative costs. The SEP, however, does not require a separate trust and is therefore often a good choice for sole proprietorship or partnership.

In reality, an owner does not need to have any employees to participate in a 401(k) plan. As a sole proprietor, an individual can receive 401(k) tax benefits through “individual 401(k)s.” In 2007, the contribution limits for these plans are a generous $45,000 per year. For those with just a few employees – even as a few as one – the Internal Revenue Service allows for a variety of other 401(k) plans. Also, there is no mandatory company match. The only requirement is that a 401(k) plan, if offered, be made available to all of a business’s employees. Surveys have shown that a majority of employees will contribute to 401(k) plans that do not offer a company match. Rather than dismiss these plans, then, it is important for owners to discuss them with a financial consultant.

Innovative plans

In addition to traditional options, financial consultants have been developing more innovative plans in recent years. These plans often focus on owners who feel that they have discharged their obligations to their employees and are concerned primarily with their own retirement. Such plans are referred to as “non-qualified” plans, meaning they are not subject to some constraints of ERISA (the Employee Retirement Income and Security Act). While ERISA governs “qualified” plans, such as 401(k)s and pensions, “non-qualified” plans allow employers to offer themselves (and upper management, if they so choose) retirement options that they do not have to make available to rank-and-file employees.

An example would be a tax-deductible deferred compensation plan. Deferred compensation plans have been around for quite some time, but “tax-deductible” deferred compensation is a more recent development. The basic mechanism behind this type of plan is that it requires participation in a Professional Employer Organization, which performs certain services for the employer and actually acts as a co-employer of the employee. In essence, this can allow upper management to take advantage of a sort of super-charged 401(k) plan.

Another advanced approach to retirement planning may involve the use of “phantom stock.” In this scenario, say an employer wants to retain a key employee but does not want to part with more stock. On the other hand, he/she wants upper management to feel that it has a powerful interest in growing the company, while being rewarded for that growth. In this case, the owner can set up an arrangement whereby the valued employee will not receive actual stock but will receive financial benefits that mirror the company’s performance. This can provide excellent benefits to key personnel and such plans are relatively inexpensive to set up.

The defined benefit pension plan is another key strategy. According to Ron Snyder, an attorney and actuary with Benefit Strategies Group, “a specific advantage that this plan has over all others is that it allows business owners who haven’t put away much – often baby boomers – to put away a lot in a short time.” These plans allow an individual who earns $150,000 a year, for example, to invest as much as $80,000 of that income toward his or her retirement. Since defined benefit pension plans make it possible for owners to achieve greater growth in a shorter time, they are very popular. In fact, says Snyder, most small companies that he works with use them.
Make retirement a priority

Clearly, a variety of retirement savings options are available, but these options, whether traditional or innovative, will do little good for those who do not use them.

Unfortunately, any financial consultant can cite numerous cases of clients who have not given retirement planning the attention it deserves. The reasons are, to some extent, understandable. Owners of diecutting and diemaking operations face a number of challenges each day, and they are worried about the endless tasks involved in keeping their businesses afloat. Still, effective retirement planning and accumulating enough money to enjoy a comfortable retirement depend heavily on commitment, making the right investment decisions, and giving one’s money time to grow. Sadly, owners who neglect these realities may find that they will never be able to retire or that they will fail to enjoy retirement to its fullest. This being the case, the owners of diecutting and diemaking businesses need to make themselves a priority, and bring the same enthusiasm and commitment to retirement planning that they bring to managing operations.