Retirement Strategies for Small Business Owners

Investment tipsNews & Tips

Published: March 26, 2022

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Owning a small business can be a highly lucrative and rewarding career path, but often entails a large number of financial challenges and responsibilities. Retirement planning is one major area where small-business owners must take special care. Small business owners are usually solely responsible for selecting and establishing retirement plans for themselves and their employees.  

There are several specific retirement planning considerations that small business owners must be aware of. By researching these factors and taking the right steps before retirement, you can make a smooth transition to post-work life and ensure continued financial security for your valued employees even after you’ve stepped down from your business.

Plan an Exit Strategy  

Once you decide you’re ready to retire, the next step is to start working on an exit strategy for your business. A carefully planned exit strategy will help you map out your post-retirement finances and determine how your business will continue to operate after you leave. As part of your exit strategy, you should identify who will take on your stake in the business and who will assume your day-to-day responsibilities once you retire. There are five main types of exit strategies that small business owners can choose from:  

  • Sale: This exit strategy entails selling your business to a party you’re already familiar with. The buyer could be a family member, colleague, or employee who has shown ownership interest. While your potential earnings from a sale can vary depending on market value, this strategy is ideal if you want to ensure your business remains in trusted hands after you retire. 
  • Acquisition: In an acquisition, you will give up ownership and your business will become part of another company. This strategy is ideal if your business is profitable but you no longer want to be involved. Acquisitions tend to net more cash than sales because they allow the owner to name their price. 
  • Merger: A merger involves combining your business with another one to form a new entity. Mergers tend to increase a business’s value, making this strategy ideal for owners who want to retain a stake in their company after retirement. 
  • Liquidation: If you liquidate your business, your company’s operations will end and all of your assets will be sold. Profits from liquidation go to creditors, and then to investors once all debts have been paid. This strategy is ideal for owners who want to exit their business quickly and completely.  

 

The optimal exit strategy for you depends on the size of your business, your organizational structure, and your current financial situation. For example, if your business already has other partners, it may be wise to sell your remaining shares to them rather than seeking out a new investor. Before you decide on a plan, you should have your business appraised to accurately calculate the fair value of your shares.  

Have Your Business Appraised  

Getting your business appraised will help you determine how much money you can earn from selling your shares and other assets. There are three common methods you can use to evaluate the different aspects of your business’s economic worth: 

  • Asset-based valuation: This approach involves calculating the total sum of the fair market values of all owned assets for a business, minus liabilities. These assets can include equipment, technology, and owned properties, as well as intangible assets like patents and trademarks. 
  • Earnings-based valuation: This type of valuation focuses on determining a company’s potential future profitability. This approach typically involves calculating a company’s estimated future cash flow and expenses, as well as any potential risks that could impact productivity.  
  • Market valuation:  This approach involves calculating the market value of your business by looking at recent sales of comparably sized entities in your industry. When you’re conducting a market valuation, an adequate sample of similar companies’ sales is required to perform a proper comparison. 

 

By carefully evaluating your assets, you can create a tailored exit strategy that will work for your unique needs, and help ensure that you have adequate savings to start your retirement.

Diversify Your Investment Portfolio  

When you’re preparing for retirement, accounting for long-term financial security is just as important as developing an exit strategy, and a diverse investment portfolio is a major part of this long-term planning. When you’re determining what assets to invest in, you should prioritize a mix of asset types such as stocks, bonds, exchange-traded funds (ETFs), and stable commodities like gold. 

By diversifying your portfolio with a balanced mix of asset classes, you can mitigate risks, protect your finances against unfavorable market cycles, and expose yourself to a wider range of potentially fruitful investments.

Establish an IRA  

As a small business owner, you must establish IRAs (individual retirement accounts) for yourself and your employees. While this extra responsibility can be stressful, it also gives small business owners a high level of control over their retirement planning.  

Establishing an IRA for your small business can help you protect your assets and allow you and your employees to steadily save for retirement. There are a handful of different IRA options available to small business owners, each with its pros and cons. The ideal IRA for you depends on several factors, so it’s critical to carefully research the different types of accounts before you make a decision.

Traditional IRA   

If you are the sole proprietor of your business, a traditional IRA may be the most prudent option for you. Traditional IRAs are relatively simple to set up and are available through most brokerage and investment companies. 

Traditional IRAs have no income requirements and allow you to defer tax payments on your contributions until you withdraw funds. However, they have lower contribution limits than other account types and charge additional penalties for any withdrawals you make before age 59½. A wide variety of investment types are available through traditional IRAs, including stocks, bonds, annuities, and share certificates. 

Roth IRA  

Another account option for sole proprietors, Roth IRAs are similar to traditional IRAs, but with some key differences. Unlike a traditional IRA, the contributions you make to a Roth IRA are not tax-deductible. While this can be a drawback in the short term, it also means that you will not have to pay taxes on the money you withdraw in the future, as you would with a traditional IRA. 

Another advantage of choosing a Roth IRA is that you can withdraw principal contributions from your account anytime, although withdrawing earnings before age 59½ will still carry a penalty. Roth IRAs have an income limit of $105,000 and are not normally available to individuals who make more than this amount annually.   

SEP-IRA  

The Simplified Employee Pension plan, or SEP-IRA, is designed for small businesses with one or more employees. These plans are flexible and relatively simple for small businesses to establish. A SEP-IRA allows you as the business owner to make regular contributions into individual accounts for yourself and your employees. 

The annual contribution limits for SEP-IRAs can vary from year to year and are usually measured by a particular dollar amount or percentage of the employee’s salary. With a SEP IRA, all the money that you contribute to you and your employees’ accounts is tax-deductible, but it will be taxed as regular income upon withdrawal. All early withdrawals (before age 59½) from SEP accounts are subject to an additional 10% tax penalty. 

SIMPLE IRA   

The SIMPLE (Savings Incentives Match Plan for Employees) IRA is a plan designed for small businesses with up to 100 employees. Unlike the SEP-IRA, this plan allows employees to make pre-tax salary reduction contributions to their accounts, which employers are required to match each year. 

The exact contribution limits for SIMPLE IRAs can vary from year to year, but businesses are generally required to match their employees’ annual contributions. With a SIMPLE IRA, you can make tax-deductible contributions to your employees’ accounts. Any earnings gained through investment growth are also untaxed, although any early withdrawals from individual accounts are taxed like ordinary income.     

Small Business 401(k)   

A 401(k) is another type of employer-sponsored retirement savings plan with its own distinct set of rules and advantages. A small business 401(k) gives employees the option to defer a portion of their annual salary to contribute to their retirement fund, which employers can match. These contributions are commonly made on a pretax basis, but some plans also allow employees to make after-tax Roth contributions to their accounts. 

The maximum annual contribution an employee can make to their small business 401(k) is limited to a specific percentage of their yearly salary. While a company 401(k) often requires more administrative oversight than an IRA, these plans can give you and your employees more flexibility in retirement planning and help you save on taxes in the long term. 

Solo 401(k)  

For sole proprietors who want more control over their retirement planning, a solo 401(k), also called a one-participant 401(k) plan, may be the ideal choice. These plans are designed for business owners who have no employees other than themselves and their spouses. With a solo 401(k), you or your spouse can elect to defer up to 100% of your annual income into pre-tax contributions. 

Your company can then match these contributions up to 25% of your annual salary. Through elective deferrals, you can save money every year by reducing your and your company’s taxable income. You can also set up a solo 401(k) with a Roth option that allows for after-tax contributions as well, which can save you from paying taxes on earnings. 

Gold IRA 

A gold IRA, a common term for a self-directed IRA, is a type of retirement account that allows investors to hold physical gold as well as gold stocks, gold mutual funds, and gold ETFs. Establishing a gold IRA in addition to your other retirement savings account(s) is an effective way to diversify your investment portfolio. Because the value of gold can rise even as the dollar drops, establishing a gold IRA helps you protect your assets from inflation and ensure continued financial security in retirement. 

To establish a gold IRA, you must first find a custodian (IRS-approved financial institution) with expertise in gold, as well as a precious-metals dealer to direct your gold purchases. Similar to more traditional retirement accounts, gold IRAs have contribution limits and rules about making withdrawals which can vary from year to year. You also have the option to roll over an existing retirement account into a gold IRA, which will help you diversify your investments and save you additional paperwork in the short term.

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