Four Buckets for Financial Security
By Gary Pittsford, CFP®
Business owners should start thinking about their financial security at an early age. Over the last 40 years, we have worked with many business owners who have reached retirement age and are now ready to sell the business and move into the new chapter in their lives. While working with those business owners, there are several common financial traits that I see far too often. In this article I will cover four different ideas to help make your future retirement income stronger. I normally refer to these four ideas as four separate buckets. All business owners should aim to start contributing to the three or four buckets outlined below at the earliest age possible.
As you read this article, try to remember an important fact. Most of you have spent 30 to 40 years building up the value of your business and your personal net worth. Calculate that net worth the day before you sell your company. Look at the numbers on your financial statement. What the numbers are, that is what you have to live on for the next 30 years. Those of you who are 65, on the day you sell your company, you will have about an 8 percent to 10 percent chance that you will live to be 100.
Bucket #1 – Business Real Estate
Between 50 percent and 60 percent of the business owners that we work with each year own the real estate where their business is located.
Most of the time we tell owners to put the real estate into a separate limited liability company and lease it back to their primary business. Keep the real estate separate from the business and charge a fair rent, or sometimes a rent that is slightly higher than normal.
Over the years it is normal for the rent to increase with inflation. The mortgage is paid down over time and most often, the real estate increases in value over time. This builds value for the owners and it’s an additional income source that can be used in retirement, or in making financial decisions with other family members.
Bucket #2 – Retirement Accounts
Some store owners have a 401k plan, a SEP plan or a simple IRA. These tax-deductible retirement options are an excellent place for you to build your net worth in an area not related to your company, and at the same time receive annual tax deductions. Remember that if you put $1 into one of these qualified retirement accounts, and if you are in the 20 percent tax bracket, it only costs you 80 cents.
If you use the same $1 to pay off a car loan, or pay down your home mortgage, it actually costs you close to $1.20, because paying off loans is not deductible. Also, over your career of 30 to 40 years, these accounts accumulate tax deferred, and you will pay taxes on the profits many years from now when you retire.
Bucket #3 – Personal Assets
If at all possible, during your working career, try to accumulate assets that are not related to the business. Accumulate assets that will grow over time and help contribute to your personal net worth and your retirement security.
Open up a custodian account and buy some stocks and bonds, or buy an apartment building or farmland.
Also, have some liquid assets that would be available to you if the company needs a capital contribution at some point in the future. As a business owner, I would much prefer to use some of my own cash in financing a new venture for my business. Bank financing at low interest rates is usually a good option, but keep the bank financing leverage at a reasonable level. Having some liquidity that you can use is sometimes better than dipping into the business line of credit.
Bucket #4 – Sale of Business
When you decide to pull the trigger and implement your succession/exit plan, you will probably be selling your first or second largest asset. Hopefully, over the years, the value of the business has increased, and you have several potential buyers. Perhaps someone within your family will work with you to design a plan to buy you out, sometimes it may be one or two key employees or it may be someone within your industry.
If the bulk of your net worth is wrapped up in the business, you need to sell the business for the highest price possible and minimize all of the income taxes on the sale. Keeping the largest amount of cash from this transaction becomes very important.
We have helped business owners for several years increase profitability, decrease expenses and increase the value of their business in the last three to five years before they sell.
If you are in your 30s or 40s, try to accumulate cash in at least three or four of the different buckets during the rest of your career. If you are in your 60s or 70s, then concentrating on the company and maximizing the sales price is probably where you should focus.
I realize that over the years, sales in your retail stores have increased, inventory has increased, payroll has increased and I hope profits have also increased.
Think about your net worth the day after you sell the business. What is in that net worth, and how much income will it generate?
Try to diversify your assets over time and make your company more valuable by making it more profitable.
Most of all, start working on that succession/exit plan at least three to five years before that big sale date.
Gary Pittsford, CFP®, is president and CEO of Castle Wealth Advisors, LLC. Castle specializes in helping families and closely-held business owners with valuations, succession planning, estate and income tax analysis and retirement income security. Castle’s senior partners work with clients throughout the country in making logical decisions that help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or e-mail Gary@Castle3.com.
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