By James O'Brien.
If you're a small-business owner, then it's easy to imagine how the company you've built can play an important role in financing your retirement. But are you getting the biggest bang for your ownership buck?
It's natural to think about end-game moves first -- a sale of the business, annuities, and the like -- but what about taking steps throughout your career, using your company to build a larger retirement account balance?
For starters, you can turn to your business's investment instruments. These can help generate returns that fuel savings. Taking both mid-career and end-phase planning into consideration, let's look at several investments you can make during your working years to ensure that your business sustains your retirement when you step away from the CEO's desk.
Simplified employee pension
The SEP is an individual retirement arrangement designed for business owners and self-employed professionals. Starting after your third year with the business, you can contribute up to 1) 25% of your compensation into the account or 2) $52,000 -- whichever is less. You don't need to do so every year, so that adds flexibility in the case of a revenue slowdown. Note, however, that if you're the owner and you contribute to the SEP IRA in a given year, you also have to contribute to the SEP IRA of all your eligible employees. Participants can withdraw money starting at age 59-1/2 without incurring a 10% tax penalty. Also, contributions are tax-deductible for the business.
Cash balance plan
If you're enjoying a good deal of compensation as a business owner and you'd like to leverage more of that income for retirement, a cash balance plan offers some attractive benefits. In essence, it's a pension plan, but it accrues based on a fixed-percentage contribution from your annual income plus returns (which are often similar to government bond yields).
Like a 401(k), a CBP allows you to make pre-tax retirement contributions to a retirement plan, but it has much higher contribution limits than a 401(k) and usually has lower costs thanks to the pooling of contributions. The formula for the CBP maximum takes into account numerous variables, but using one of many online contribution calculators, we can see that if you were born in 1974, then your contribution to a cash balance plan in 2014 could be as high as $74,470 (and that's tax-deductible for your business as well).
At retirement, CBP participants can take a lump-sum distribution or an annuity from their plan. Let's say you have $100,000 in your CBP and you end work at 65. You could draw $5,000 toward your annual income for the next 20 years, or $10,000 for 10 years, for example. You could also take a lump sum and roll that into an IRA.
Buy-sell agreement
If you've built your business with partners, you'll want a contract that defines the price you'll get for your interest in the business when you retire. A buy-sell agreement is that kind of instrument, setting in writing, among other details, the price of your share in the company (or the way the price will be calculated) at the point of your retirement. The agreement further determines whether the buyout amount will come as a lump sum or in installments, as well as what form (cash, stocks, etc.) the payment(s) will take.
Note that a buy-sell agreement is not only about money; it's also about legacy. Having built the business, you'll want to set terms that won't cripple it -- for example, by forcing it to liquidate too much, too fast -- when it starts to finance the end of your leadership.
Make sure those years of hard work pay off
Amplifying your retirement savings, taking advantage of their tax benefits, and preparing your business to become a retirement-income instrument are three of the most powerful ways that business owners can leverage their life's work for future income.
One last note: Remember to look for tax credits that apply to your retirement efforts.
Examples include your costs to set up and administer a SEP IRA and your retirement plan contributions. These credits can generate substantial tax savings as you go. And of course, you can then put that cash back into the business or add it to the balances you're building for the future. Either way, you're working smarter when it comes to your business and your retirement plan.
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