5 Retirement Planning Secrets Every Entrepreneur Should Know

I am a business owner, planning for retirement alongside my clients, many of whom are also entrepreneurs. You could say I am surrounded by the choices and impacts of decisions entrepreneurs make when it comes to their own retirement planning.

defined benefit plan, Solo 401(k), financial planning for entrepreneurs

And in 14 or so years of this, I’ve seen it all.

I often get asked what special considerations should be involved in retirement planning for entrepreneurs. In other words, what secrets do successful entrepreneurs know about achieving financial success?

In my professional opinion, successful retirement planning for entrepreneurs follows these 5 guiding principles:

1. Start with the End in Mind

Your business is your empire, so you need to understand its prospects and its limitations–most importantly; when and how will you make your exit? 

If you are already running a business, you should know your business type, and what that means about the potential ways you can exit or sell the business. This will inform the planning and saving you need to do to retire successfully. 

If you haven’t started your business yet, you have the opportunity to consider what type of business can provide for the kind of life you want–both while you are running it and when you leave it.

Some of the most common exit strategies are:   What's your exit plan?

  • Initial Public Offering
  • Buyout from a large corporation
  • Franchises, where you can cash out slowly over time
  • Sell the business to an individual owner

Entrepreneurs who don’t plan for a lucrative exit are often forced to simply dissolve their business when they leave it, with no financial benefit, so that’s why exit planning is critical.

Stay tuned for an entire blog post on just this topic coming up. 

2. Consciously Grow Personal Income and Business Value

Too often, I hear of entrepreneurs who have run a business for several years, socking every penny of revenue back into the business.

You as the business owner need to decide how long your profit runway is, but 2-5 years is the right timeline for the vast majority of businesses. Also, the number of years you’re willing to operate without significant personal income or net worth growth should depend on the potential payout.

If you’re running the next would-be Facebook, 5-7 years at the helm makes perfect sense.

But if you’re selling a physical product and struggling for years with distribution and sales, you’ve got to be willing to iterate the product, or fail fast.

Remember that in business, you never consider sunk costs (all the blood, sweat and tears you’ve already put into your business) when you evaluate future revenue prospects.

3. Beware of Lumpy Income

The financial planning community can seem to have a set-it-and-forget-it attitude when it comes to strategies to achieve your retirement savings number.

A common rule of thumb is to start with 10% in your 20’s, arrive soon at a comfortable lifestyle, and then during the decades in which most people can expect earning to be at its  highest, continue to save raises and other small windfalls like inheritances and bonuses.

Actually, research has shown that this kind of saving strategy, which is referred to as burst savings, is most likely to lead to financial success.

But this is far more easily said than done for an entrepreneur!

Entrepreneurs will almost certainly experience very lumpy income over their working lives.

Serial entrepreneurs especially can experience dramatic income swings. For example, most CEOs of VC-funded startups take a salary of maybe $50,000 in the beginning, hoping for a multi-million dollar exit down the road.

In the beginning, keep your personal overhead as low as you can, and save as much of any cash influx as possible until your personal net worth is secured.

Knowing how much you’ll need to have in savings if you choose to stop working or need to stop working is very important. You’ll need to understand your own needs for financial comfort as well as your investment portfolio’s payout rate. This is where a financial planner can do her most valuable work with entrepreneur clients.

4. Be Smart About Risk  Successful entrepreneurs are smart about risk.

A hallmark of entrepreneurialism is confidence. Congratulations! You are likely full of optimism and a strong sense that you are destined for greatness.

Confidence serves entrepreneurs well, because being in business is very risky. In many ways, we entrepreneurs have to have brains that allow us to ignore the true risks of the situation, and step out on the tight wire anyway—statistics be damned!

However, it’s important to train yourself to take only calculated risks, and to manage the various areas of life where you are taking risk.

For example, let’s say a particular serial entrepreneur is 40 years old, and just successfully sold an engineering firm she built for $1,000,000.

She puts $300,000 into a down payment on a Silicon Valley home and invests the rest.

This entrepreneur is justified in feeling confident and successful!

And, she has not earned enough to stop working, or retire and replace her income.

Yet she might feel so confident in her success and business acumen that she’d really like to take $250,000 of her windfall and invest it in her business school colleague’s medical device startup.

But that wouldn’t be a calculated risk. This CEO has proved her mettle at founding and selling companies, not at selecting pre-IPO investments.

Not only that, she can’t afford to risk that much of her net worth on a single investment, which can easily go to $0.  

It’s important for entrepreneurs to have their own Board of Directors—a Financial Dream Team if you will. You need to surround yourself with educated and successful people who can help you evaluate opportunities rationally.

Exuberance can be a very dangerous thing to an entrepreneur.

Decide consciously the areas of your life in which you are going to swing for the fences, and then until you’ve got more money than you need, be very calculating about risk.

5. Maximize Tax Benefits

Entrepreneurs have more planning work to do

Entrepreneurs have more planning work to do

I often say that tax-deferred savings is probably the only freebie you’ll ever get from Congress. Run with it!

Congress permits you a myriad of options when it comes to saving tax-deferred money for retirement. Consult a retirement plan expert for your own options, as they are a function of your business and revenue structure.

Many entrepreneurs rely on their tax preparer for this recommendation; but I find that tax preparers often simply recommend the SEP (Self-Employed Pension) without considering other options.

Don’t get me wrong, tax folks are some of my favorite people in the world. All I’m saying is consult the right expert for you, your situation, and the outcome you want for your retirement options. .

Regular employees of most corporations are limited to $17,500 per year in tax-deferred savings in a 401(k). Folks whose employers don’t offer a plan are even worse off: limited to $5,500 in a traditional IRA or Roth IRA if they qualify.

Entrepreneurs are permitted to save a lot more than W-2 employees on a tax-favored basis.

Often in the beginning, the best way to determine which account type is best is to wait until the next calendar year, when your tax preparer has determined your taxable and self-employment income. Most account types permit contributions to be made in the new year, and ear-marked for the previous year. 

That said, for some account types, the actual account must be open by December 31st of the tax year.

4 Most Common Account Types for Business Owners

1. Solo 401(k):

For entrepreneurs with no employees, you can include your spouse. You are the employee and the employer so you can add $17,500 in employee contributions and up to 25%, or a maximum of $52,000 of additional self-employment income in 2014.

That’s almost 300% more than regular employees of corporations are permitted!

2. SEP IRA:

You can contribute as much as 25% of your net self-employment income, up to $49,000.  One cool thing about the SEP is that if you’re building your new business on the side while still maintaining employment where you contribute to a 401(k), you can still contribute to a SEP. This plan is best for business owners with few or no employees.

3. SIMPLE IRA:

Similar to the Solo 401(k), some contributions are considered to be from the employer and some from the employee. Employee contributions can’t exceed $12,000 in 2014. Employers are required to match each employee’s salary reduction on a dollar-for-dollar basis up to 3% of compensation, or the employer can choose to make a standard non-elective contribution.

Additional, catch-up contributions to most accounts, including standard 401(k)s, are permitted if you are over age 50.

4. Defined Benefit Plan:

This is a traditional pension plan where employees can expect a fixed and pre-determined benefit at retirement. Defined Benefit plans are designed for a high cash flow business where revenues are consistent. Regular and high contributions are required, but can afford entrepreneurs who have built successful businesses much higher tax benefits than are available with the other types of accounts.

If you have questions about how to determine which of these account types is right for you and your business, please email me. I’m happy to help guide you.

My Wall Street Journal Interview on Retirement Planning for Entrepreneurs

 

Wall Street Journal

Hilary at National Financial Advisor Week

Recently, I had the privilege of sharing some insight about working with entrepreneurs with Wall Street Journal Reporter Dasie Maxie, while in New York City for National Financial Advisor Week (check out the pic over there to the right). 

Here’s the interview, I hope you enjoy!

 

What have been your best successes or most important lessons learned as an entrepreneur building your own financial success? Let me know in the comments!

Please note: I reserve the right to delete comments that are offensive or off-topic.

Leave a Reply

Your email address will not be published. Required fields are marked *