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Business Succession

Retirement Planning for Business Owners

For many employees, saving for retirement is usually a matter of simply participating in their employer’s 401(k) plan and perhaps opening an IRA for some extra savings.

But, when you’re the owner of a business, planning for retirement requires proactivity and strategy.  It’s not just the dizzying array of choices for retirement accounts, there’s also planning for the business itself.  Who will run the business after your retirement?  Additionally, your estate plan must integrate into your retirement and business transition strategy.

Owners of businesses (like employees and everyone else) want to make sure they will have enough money in retirement.  Business owners recognize the value of their businesses, so they are often tempted to reinvest everything into the enterprise, thinking that will be their “retirement plan.” However, this might be a mistake.

Retirement Accounts for Business Owners

Rather than placing all your eggs in one basket, it makes sense to have some “backup” strategies in place.  There are many retirement account options open to business owners.  Although the number of options can make things confusing, a tax and financial professional can often quickly make a recommendation for you.

For example, you may consider opening a 401(k), SEP-IRA, SIMPLE, or pension plan.  This can reduce your income taxes now, while simultaneously placing some of your wealth outside your business.  From a financial perspective, these account are tax-deferred, so the investment growth avoids taxation until you retire, which greatly boosts returns.  The “best” plan really depends on how much income your business earns, how stable your earnings are, how many employees you have, and how generous you want to be with those employees.  You must consider how generous you’ll be with employees because the law requires most tax-deferred plans to be “fair” to all employees.  For example, you can’t open a pension or 401(k) for yourself only and exclude all of your full-time employees.  When making this decision, consider that many employees value being able to save for their retirement and your generosity may be repaid with harder work and loyalty from the employees.

Depending on how many employees you have, you may even consider “self-directed” investment options, which can allow you to invest some or all of your retirement funds into “alternative” investments, such as precious metals, private lending arrangements, real estate, other closely held businesses, etc.  These self-directed accounts are not for everyone, but for the right person, they open up a wide world of investment opportunities.  The tax rules surrounding self-directed tax-deferred accounts are very complex and penalties can be incredibly high.  So, if you choose to do self-directed investments, always work with a qualified tax advisor.

Outside of your business, you can likely contribute to an IRA or a Roth IRA.  This can allow you to add more money to your retirement basket, especially if you’ve maximized your 401(k), SEP, or SIMPLE plan.  Like the other tax-deferred accounts, self-directed IRAs are also an option, opening up a broad world of investment options.

As a business owner, you likely have a great deal of control over your health insurance decisions.  If you’re relatively young and healthy or otherwise an infrequent user of health care services, consider using a high deductible health plan (HDHP) and a health savings account (HSA) to add additional money to your savings.  These plans let you set aside money in the HSA which can be invested in a manner similar to IRAs.  At any time after you setup the account, you can withdraw your contributions and earnings, tax-free, to pay for qualified medical expenses.  And, after you turn 65, the money can be used for whatever purpose you want, although income tax will need to be paid on the distributions.

Selling or Transferring the Business

Many business owners dream of a financially lucrative “exit” when a business is sold, taken public, or otherwise transferred at a significant profit for the owner.  This does not happen by accident – a business owner must first create and sustain a profitable enterprise that can be sold.  Then, legal and tax strategies must be coordinated to minimize the burdensome hit of taxes and avoid the common legal risks that can happen when businesses are sold.  When a business is sold, the net proceeds can form a significant component of the owner’s retirement.  When supplemented by one or more of the retirement accounts discussed above, this can be a great outcome for a business owner.

On the other hand, other businesses are “family” businesses where children or grandchildren will one day become owners.  Like their counterparts who will sell their businesses, these business owners must also focus on creating and sustaining a profitable enterprise, but the source of retirement money is a little less clear.  In these cases, clearly thinking through the transition plan to the next generation is essential.  Although the business can be given to the next generation through a trust or outright, there are also transition options to allow for children, grandchildren, or even employees to gradually buy-out the owner, if the owner needs or wants to obtain a portion of the retirement nest egg from the business.

The Importance of Estate Planning

Regardless of which retirement accounts (401(k), SEP, SIMPLE, IRAs, HSAs) you select, it is wise to integrate them into your estate planning.  You’ve probably already considered who you want to take over your business after you retire (perhaps a son or daughter or a sale to a third party).  For your retirement accounts, an IRA trust is a special trust designed to maximize the financial benefit, minimize the income tax burden, and provide robust asset protection for your family.  These trusts integrate with the rest of your comprehensive estate plan to fully protect your family, provide privacy, all while minimizing taxes and costs.

Leverage the Team Approach

Let us work with you, your business advisors or consultants, your tax advisor, and your financial advisor to develop a comprehensive retirement, business transition, and estate planning strategy.  When we work collaboratively, we can focus on setting aside assets for retirement, saving as much tax possible, while freeing you to do what you do best – build your business!

Contact us or give us a call today so we can help you craft a retirement, business transition, and estate planning strategy.

Rewarding Your Employees by Giving Them the Business

Retiring from your business can a tough decision.  To ensure that what you have built continues on, there needs to be a plan for succession.  For some people, they have spent years grooming a child or other family member to take over, wanting the business to stay in the family.  Others look to sell to a third party for a quick way out that will also give them a nest egg for their next phase of life.  However, there is a third option–transferring the business to your employees.  If you like the idea of transferring your business to long-time faithful employees who have contributed greatly to the company’s success over the years, below are a couple of options for you to consider.

Management Buyout

This type of transfer is a process, not an event.  The management team comes together with the financing and arranges a deal with you to buy the assets and operations of the business.  A management buyout has the benefit of being quicker and more confidential than a third party transaction, and the structure of the deal can be more flexible.  There is also the added benefit that the legacy of the company will continue in the hands of those in management who have earned the opportunity to buy the business with his or her loyalty and hard work.

With this option, you may also be able to provide some continued service to the company as an officer and/or director.  In addition, you may even be able to continue in some part of the business that you enjoy.  And you may be able to keep some control over the company.

When considering this option, it is important that you consider the following:

  • How much cash, debt, and earn-out will be involved?
  • When will the transfer of control occur?
  • If management has little or no capital, where will they get the money for the buyout?

Employee Stock Ownership Plans (ESOPs)

An ESOP is a qualified plan under the Employee Retirement Income Security Act of 1974 (ERISA).  Instead of selling directly to management, you are making the sale to the ESOP, which has been set up by the company.  The ESOP can either attempt to get bank financing to purchase the stock from you, or you can take a note for the value of your shares and have the repayment taken care of internally.  The employees become plan participants, similar to other employee incentive programs and are entitled to benefits at certain points as determined by the terms of the ESOP.

This option is similar to a management buyout, but with potentially valuable tax benefits.  With an ESOP, you are selling stock in the company, not the assets, so the taxes are capital gains, not ordinary income taxes.  Because of this distinction, there are planning techniques available that may help save on taxes with this transaction.

When reviewing this option, there are a few things to consider:

  • In order to repay the note, most (if not all) of the excess cash flow from the business may be needed, instead of using it to grow the company;
  • The company must set aside money to meet repurchase obligations on the ESOP when an employee retires, dies, becomes incapacitated or terminates his or her employment after vesting;
  • Stock in an ESOP is allocated based on payroll, so there are no extra management incentives.

Both management buyout and ESOPs are options that should be considered if you are looking to transfer your business to your employees.  However, we are here to help you.  Give us a call or contact us, we would be happy to discuss these options more and find a solution that best protects you and your legacy.