INSIGHT: Strategies for the Business Owner

Business owners have so many responsibilities that planning for retirement is often overlooked. According to a recent Manta survey, 34 percent of business owners do not have a retirement plan; the majority of their wealth is tied up in the business, and selling the business is their plan to fund their retirement years.

Although more than 70 percent of business owners take action to mitigate business risk by owning insurance, 40 percent identify that developing a retirement plan and an exit strategy is their most pressing issue. (https://www.cnbc.com/2014/08/19/cnbcfinancial-planning-association-survey-finds-small-business-owners-are-too-focused-on-their-business-to-plan-for-their-own-financial-futures.html.) Business owners have a wide array of planning options that can help reduce taxes, attract and retain employees, increase business value, provide for a family legacy and build a more secure retirement.

Retirement planning for business owners can often be thought of as a three-legged stool, with each leg representing one component of a successful retirement roadmap. The goal is to focus on all three to ensure it is balanced.

The first leg includes establishment of a qualified retirement plan such as a profit sharing plan, or a defined contribution plan like a 401(k) or simplified employee pension IRA (SEP IRA). These plans are sponsored by the employer and must meet certain requirements to allow for the deduction of plan contributions as a business expense. The plans allow for retirement savings in a tax-efficient manner and vary according to who can contribute to the plan, contribution limits, and administration. The most typical are:

• A solo 401(k), also known as a self-employed 401(k), is for business owners with no employees other than a spouse (and no plans to add employees). For 2018, the employee pre-tax contribution (or post-tax if Roth option is available) is $18,500, or $24,500 for those age 50 or older. Employer and employee contributions cannot exceed $55,000 and are limited by income based on the business structure.
• An SEP IRA is for self-employed individuals and small businesses with no limit on the number of employees. Contributions are made entirely by the business and tax deductible as a business expense. The maximum contribution cannot exceed the lesser of $55,000 or 25 percent of compensation, and employers must contribute the same percentage to employee accounts as they contribute to their own.
• A savings incentive match plan for employees (SIMPLE IRA) is for businesses with 100 employees or less. It can be funded by tax-deductible employer contributions and employees can make pre-tax employee contributions up to $12,500 or $15,500 for those older than 50.
• A 401(k) plan may be appropriate for businesses who want flexibility in the design of the plan as compared to SIMPLE and SEP IRAs. However, this comes at an additional cost to the business owner in setup, administration, and fiduciary responsibilities. A 401(k) has the same contribution limits as the self-employed 401(k), however it must meet certain requirements, and contributions must not discriminate in favor of highly compensated employees (in 2018, this is defined by individuals with compensation in excess of $120,000).

The second leg of the stool includes more advanced strategies such as non-qualified plans which focus on the key employees and the business owner. These plans serve as a tool to recruit and retain top talent, provide performance-based rewards, and may fill the retirement income gap left by qualified plan limitations. These plans do not give the employer and the employee simultaneous tax deduction and tax deferral like the qualified plans. Such plans may include deferred compensation plans, executive bonus plans, and split dollar plans.

Under a non-qualified deferred compensation plan, contributions are made to the plan by an employee, resulting in deferred income that can include salary, bonus, and commissions. It can also be an arrangement between an employer and a key employee whereby the employer agrees to pay additional compensation in the future given that certain conditions are met. While there can be substantial tax benefits to an employee contributing dollars to the plan (deferral of income) there are disadvantages, such that the plan is a liability of the company and subject to the general creditors of the company. However, employers may wish to consider purchasing corporate owned life insurance to help cover the liabilities of the plan should the company be liquidated. The non-qualified deferred compensation plan is in contrast to a qualified plan in which vested plan assets belong to the employee.

An executive bonus plan (tax code Section 162) is another tool to reward key talent and provide for additional benefits. It typically involves the purchase of life insurance and grants the employer discretion to select which employees to cover and determine the bonus provided. The employer generally pays the premiums on the policy, and the employee is charged with taxable income equal to the amount of the premiums. The employer can also “double bonus” the employee to pay for any income taxes due. The bonus amounts are tax deductible to the employer as a business expense (provided they are considered reasonable). The policy is owned by the employee although additional agreements specifying terms are typically created.

A split dollar arrangement or plan (SDA) is a cost-effective and tax-efficient way to provide benefits using life insurance. It can be used by business owners to create estate planning liquidity and retirement income. An SDA is an agreement between an employer and an employee to split the premium payments and the benefits (cash value and death proceeds) of a life insurance policy on the employee’s life. The policy can be owned by the employer or employee and ownership of the policy will determine its tax treatment. Typically, the employer will own the policy and pay the entire premium while the employee is taxed on the current value of a “term insurance” benefit provided. One additional benefit obtained by the employer, unlike other non-qualified plans, is that the business usually recovers the cost, and the death benefit proceeds are typically received income tax free by the named beneficiaries.

The last leg, and probably the most impactful to a business owner, is the use of the business asset in planning for retirement. Some exit paths can include transfer to family members, sale to key employees, transfer via employee stock ownership, sale to co-owners or a third party, and passive ownership. An exit plan can provide you a comprehensive road map to exit your business, when and how you choose as well as the ability to integrate your personal and business objectives.

Three questions to consider in planning for your exit are:

(1) What is the value of my business and other resources?

(2) How do I maximize and protect my business value?

(3) How will the sale or transfer of the business occur?

A point to consider is that selling your business is a process; not an event. It is important to establish a business value base and put strategies in place to optimize cash flow, implement company growth strategies, diversify your customer base, build a successful management team, and create a succession strategy.

Just like a three-legged stool that will not stand if one of the legs is broken, a business owner’s retirement plan needs to be balanced and well crafted. The ingredients of a successful exit and retirement is based on the unique needs of the owner, quantified business value, experienced advisors, and time.

Tessie Yuste, CFP®, CIMA®, CDFA®, CTFA, is a Senior Financial Advisor with Cherry Bekaert Wealth Management LLC. Investment Advisory Services and insurance products are offered through Cherry Bekaert Wealth Management LLC. Cherry Bekaert Wealth Management LLC and Cherry Bekaert LLP are affiliated companies.