Part of the America’s Entrepreneurs Special Report
My dad was a small business owner whose engineering and consulting firm provided a solid income for him and supported our family. When he realized none of his four children were going to take over the business, he sold it at age 70. Dad didn’t have a retirement savings plan per se — the sale of the business was his retirement plan (plus Social Security and some rental income).
Will Small Business Owners Face a Retirement Crisis?
Turns out, the way Dad approached retirement savings is pretty common for small business owners today. And that’s more than a little troubling. According to a recent BMO Wealth Management survey of 400 small business owners, only a fraction of America’s entrepreneurs are prepared for retirement. (I’ll offer retirement-planning advice for small business owners shortly.)
A striking 75 percent of survey respondents age 18 to 64 have saved less than $100,000 for retirement. Those age 45 to 64 are only marginally more prepared: 32 percent have over $100,000 in retirement accounts and only 11 percent have more than $500,000.
I was pleased, however, to see that 39 percent of business owners age 45 to 64 — the ones closing in on retirement —had traditional IRAs or Roth IRAs and 29 percent were saving in 401(k)-type accounts.
Taking money out of a business impinges on growth prospects and it can make it hard to maintain the business.
— David Deeds, University of St. Thomas
Why don’t more small business owners save for retirement?
As with my father, “the business is their retirement plan,” says David Deeds, the Schulze Professor of Entrepreneurship at the University of St. Thomas in Minneapolis. “The plan is that when they retire, they are either going to transfer the business to a family member in exchange for a share of future wealth or a buyout or they are going to sell it off and turn that into cash.”
Danger of a Common Approach
This all-your-eggs-in-one-basket approach can be dangerous for a variety of reasons, though.
“There is a risk level to it,” says Deeds, who is also editor-in-chief of EIX, the Entrepreneur & Innovation Exchange, a social-media learning platform designed to improve the success rate of new business ventures. “If the business fails, your wealth goes away.”
When business owners age 45 to 64 were asked by BMO Wealth Management what contingency plans they had if their business couldn’t be sold or if the proceeds wouldn’t be sufficient for their retirement, 28 percent said they’d delay retirement.
I hope their health holds out. When the Employee Benefit Research Institute surveyed retirees earlier this year, 55 percent of those who retired earlier than they’d planned did so due to health problems or disability.
Why Entrepreneurs Aren’t Saving Much
For small business owners, it’s not that they don’t want to save for retirement outside of their businesses. Their priority is to plow earnings back into the business to keep it growing, so they rarely pay themselves a big salary.
“If you are a small business owner, much of your wealth is trapped in your business. The problem is in order to diversify that wealth, you have to remove that wealth from the business, and, in essence, remove some of the lifeblood from the business,” Deeds says. “Taking money out impinges on growth prospects and it can make it hard to maintain the business.”
Another reason for the shortage of retirement savings could be that many businesses are fairly modest. When owners were asked the value of their business if it were sold today, 55 percent estimated less than $500,000. Only 13 percent believed their businesses were worth more than $1 million.
Dave Bensema, regional leader of planning, Illinois at BMO Wealth Management, says entrepreneurs need to take time away from working in the business spend more time working on the business. “A key question for business owners, whether from a retirement perspective, a potential sale, or even the continued operation of a business is “Does the business run without me?,” says Bensema. If the answer is No, there could be difficulties valuing the business, finding a buyer or even generating income from it when you’ve left or are less active in it, he notes. “Once you know what income might be, then you can back into how much you need to save,” adds Bensema.
5 Retirement Savings Tips for Small Business Owners
Here are five ways small business owners can ramp up their savings for retirement:
1. Run your numbers. Ask yourself: How much will I need to live on in retirement, especially when the business isn’t picking up the tab for some expenses? Just getting a sense of what your living costs might be when you quit working could be the retirement-savings wake-up call you need. Most major financial services firms such as Fidelity, T. Rowe Price, TIAA and Vanguard offer fee online retirement worksheets and calculators to help you get a bead on future expenses.
2. Consider hiring a financial adviser to jump start your retirement plan and help you focus. I recommend one with the Certified Financial Planner (CFP) designation. A few searchable databases: the National Association of Personal Financial Advisors, The Garrett Planning Network, the Financial Planning Association and the Certified Financial Planner Board of Standards.
3. Start a diversified retirement plan. You don’t have to throw a gob of money into it, but the funds will help trim your tax bill now and grow tax-deferred until you make withdrawals in retirement. In most cases, the cost of opening and administering a plan is pretty small. The 401khelpcenter.com site has a free directory of firms that sell retirement plans to small business owners.
The four main options: a SEP-IRA, a SIMPLE IRA, a Solo 401(k) and a SIMPLE 401(k). For all but SEP-IRAs, a business can be a sole proprietorship, a partnership, a limited liability company or a corporation.
A SEP-IRA is a tax-deductible retirement plan like a traditional IRA and great if you’re the company’s only employee (as I am). For 2016 tax returns, you can contribute up to 25 percent of your compensation or $53,000. One caveat: If you have employees, you generally must also fund SEP-IRAs for them.
A SIMPLE IRA is a retirement plan for owners with 100 or fewer employees. Contributions are pre-tax and taken directly out of employee paychecks, similar to a 401(k). Your contribution can’t exceed $12,500 in 2016, $15,500 if you’re 50 or older.
A Solo 401(k) is for self-employed people without employees (except perhaps a spouse). The IRS lets you contribute this year, pre-tax, up to 25 percent of your compensation plus an employee’s contribution of up to $18,000 (or $24,000, if you’re 50 or older). But your total contribution can’t exceed $53,000. If your spouse works with you, she or he can also put in the same amounts.
A SIMPLE 401(k) is for businesses with 100 or fewer employees. You and your employees may contribute up to $12,500 for 2016; $15,500 for people 50 and older. You and your employees can borrow against the money in your 401(k) accounts and make penalty-free withdrawals due to financial hardship.
4. Keep it simple. When investing, go for a globally diverse mix of low-cost index funds (or ETFs). You might buy three funds: an index fund that invests in the entire U.S. stock market; one that owns developed foreign stock markets and a smattering of emerging stock markets and an index fund that owns the broad U.S. bond market.
Simpler still: invest in a target-date fund that automatically adjusts the balance of your fixed-income (bond) investments and stocks based on your age. Select your target-date fund based on the year you expect to retire. The biggest target-date fund families are Fidelity, T. Rowe Price, and Vanguard, though most financial institutions offer them, too.
5. Check out 401 (k) plans targeted to small businesses. Some 401(k) providers are actively targeting small businesses these days. In August, Capital One, for example, launched Spark 401k, providing low-cost, all-ETF 401(k) plans for businesses with fewer than 100 employees. It offers access to retirement planning experts, too.
According to Capital One’s research, 60 percent of small business owners don’t think they have enough employees to offer a plan, which is a prevalent misperception, says Stuart Robertson, president of Capital One Advisors 401k services. “The truth of the matter is any size business, even an owner-only business, can have a 401(k) plan.”