The majority of Americans who are working class are employed by companies that offer retirement savings options in the form of a 401(k), 403(b), or pension plan. Because these contributions are automatically deducted from the employee’s paycheck, saving for retirement tends to be a rather painless process. Over time, the cumulative effect of regular monthly contributions leads to a nice sized nest egg that can be used in the retirement years.
For entrepreneurs, the story is different. Many of them don’t have a steady paycheck or employer-sponsored plans, so they don’t save for retirement. This might not seem like a big deal in the early years, but it can be dangerous and irresponsible as entrepreneurs age.
By the Numbers
Although a majority of business owners will never sell their business, a large portion of their net worth is still invested in the company. This means that when they retire, they will lose a substantial amount of their total worth.
The EPI estimates that three fourths of the 351,000 businesses in the middle market will attempt to sell by the year 2030. Furthermore, it is anticipated that only one fourth of those businesses will be deemed market-ready when they do go on sale.
If you invest all of your money back into your business, you are taking a very large risk, as only 3% of business owners will be able to sell their businesses without losing money in the next 9 years.
Entrepreneurs and Retirement: Troubling Data
Small business owners are falling short in their retirement savings, according to a survey by Manta.
According to a survey done by Manta, 34 percent of entrepreneurs do not have a retirement savings plan, even though 60 percent of them say they want to retire before the age of 65. The majority of the people that do have a retirement savings plan are significantly underfunded according to their age and retirement goals.
The question is, why are entrepreneurs failing to give retirement the attention it deserves? Here are a few of the more pertinent factors:
- Putting everything into the business. According to the Manta survey, 37 percent of entrepreneurs say they don’t make enough profit to save for retirement. Of the profit that these entrepreneurs do make, they’re pouring most of the funds back into the business to build and grow. This is smart, to a degree, but can eventually set a well-intended entrepreneur back.
- Laziness (a lack of planning). Some entrepreneurs are simply lazy. They view retirement planning as some complicated process that requires lots of meetings, micromanagement, and constant attention to market performance. This perception – as flawed as it is – discourages many from sitting down and developing a plan.
- Planning to sell the business. Right around 18 percent of entrepreneurs plan to sell their business to fund their retirement. Unfortunately, most business owners overestimate the value of their companies and don’t account for how challenging it can be to find a buyer. (Not to mention companies frequently fail, which can leave an entrepreneur without any assets.)
- No plans to retire. Believe it or not, 12 percent of entrepreneurs say they have no plans to retire. And while this may be true for some, health issues and dwindling motivation ultimately force most people to clock out for good.
- Don’t see the need. A small segment of entrepreneurs see no value or need in saving for retirement. They’d rather spend their money now and wing it during their final years. Most of these individuals assume that Social Security will cover their needs, even though it’s rarely enough to survive on.
How Much Should Entrepreneurs Save for Retirement?
It’s important to save money for retirement because it gives you financial security in your later years when you might not be able to work anymore. For some people, their retirement savings are enough to do things like travel or pick up new hobbies. For others, the money is necessary to pay for things like healthcare or to get out of debt.
There’s no retirement number that’s universally regarded as perfect. Your retirement savings needs depend on your personal circumstances, goals, needs, hopes, and dreams. But there are some rough guidelines you can use to estimate a retirement savings goal.
RISE suggests that, as a general rule of thumb, you should aim to have saved at least 10% of your income by the time you retire, and withdraw 4% annually from your retirement savings once you do retire. Additionally, there are other, more specific milestones you can aim for, such as having your annual earnings saved up by the time you’re 30, and six times your annual income saved up by the time you’re 55.
Although the following suggestions are oversimplified, they provide a good place to start when considering how much money you will need to have saved up for retirement. Many factors, such as health needs, insurance, and lifestyle, must be carefully considered and taken into account when making retirement projections. Therefore, it would be wise to consult with a retirement planner or financial advisor.
The Holistic Approach to Retirement Planning for Business Owners
There are many benefits to owning your own business, including a higher income than you could earn working for someone else. However, it’s important to understand how financial planning can help you reach your personal financial goals no matter what happens with your business. Once you understand how financial planning can help grow the value of your business, you unlock the potential to experience rapid growth in your net worth.
Business owners may increase their net worth by a factor of two every three to five years by having a comprehensive personal and business plan. This is not a guaranteed result, but by working with a financial adviser to create a comprehensive personal financial plan, you can help insure yourself against a poor outcome if your business is not successful.
You shouldn’t bet all your hopes and dreams on selling your business. Using your business to help reach your retirement goals is a better idea, but it should only be a part of your retirement plan, not the whole thing. Investing all your money in the business and just trying to make it more profitable is usually a bad idea. You might make a lot of money while you’re still running the business, but when you retire, that income will stop.
If you want to retire successfully, you should invest in things outside of your business and work to make your business more valuable. This will help you reach your goals even if you don’t sell your business.
Useful Tips on Retirement Planning for Business Owners
Although you are not employed by anyone and are therefore not eligible for an employer-sponsored retirement plan, this does not mean that you cannot save for retirement. On the contrary, this means that you need to be more disciplined and careful with putting money away for the future.
Know Your Options
The first step is to understand your options. Some of the more popular include:
A Roth IRA is a type of investment account in which you contribute money that you have already paid taxes on. This money can then be withdrawn tax-free at retirement. The contribution limit for those under 50 is $6,000 per year, and for those over 50, it is $7,000 per year.
A traditional IRA is a retirement savings account that allows you to contribute pre-tax money, which reduces your tax bill in the contribution year. With a traditional IRA, you will be taxed upon withdrawal. It is important to note that you can only contribute a total of $6,000 to both your traditional and Roth IRAs combined. Most people choose to contribute to one or the other.
The Solo 401(k) is a good option for business owners who want to invest more than the maximum of $6,000 per year. With a Solo 401(k), you can contribute up to $50,000 of pre-tax business income per year.
There are a few other retirement products, but sometimes the simpler products are the best. Start with one of these products (or a combination of a few) and see how it goes.
Create a Budget
Most financial advisors suggest saving 10 to 25 percent of each paycheck for retirement. To be consistent, you will need to budget each month to stay on track.
Your budget can help you figure out how much you can invest each month while still being able to cover your regular expenses, pay off any debts you have, and take care of other needs. Then you can set up automatic monthly deductions from your bank account so that investing is easy and hassle-free.
Diversify
You will need to decide what to invest your money in if you have an IRA or Solo 401(k). Depending on what your retirement goals are, you should diversify your investments to achieve growth and / or income, as well as managing the overall risk to your portfolio… particularly as you get closer to your retirement. Develop a plan and work your plan.
Tax Mitigation
Taxes are overlooked by many in their retirement income planning process. If all of your retirement contributions are made with pre-tax dollars to get you an immediate tax benefit, you must remember that you will be sharing your harvest with Uncle Sam. If your retirement tax bracket is 25% and you request $1000 distribution from your retirement account, the net amount you will receive is $750 (with the other 25%, or $250, going to the government).
The numbers show that there are benefits to looking at the big picture (including outside of your business) when planning for retirement. If you can reduce your tax bill through smart planning, you can build more wealth. This can be used to help diversify your portfolio and improve your position for retirement.
Keep Your Hands Off
Don’t touch your retirement account! It can be tempting to take money out when the market isn’t doing well, or to invest more when it’s doing well, but resist the urge. Making regular investments in both good and bad markets will help you earn a healthy rate of return. Also, don’t withdraw your money before you’re supposed to! There are fees and taxes involved that make it not worth it.
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