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Managing a Small Business Owner’s Retirement

By Ellen Sheng February 25, 2021

For small business owners, whose wealth is inextricably tied to their business, the task of coming up with a solid retirement plan can be tricky.

When your clients own their business, the personal and professional are more intertwined than the average employee. Business owners tend to plow back much of their cash flow into their business. Additionally, the majority of small businesses don’t have succession plans, and those who plan to sell in the future often overvalue the business.

Many feel like retirement is something far in the distant future — regardless of their age. As a result, owners haven’t put all the pieces together or planned what they’re going to do in retirement. To avoid last-minute scrambling, advisors need to push clients to think about retirement and succession.

“Lots of business owners don’t really think about how useful retirement planning can be,” says Sam Brownell, founder of Stratus Wealth Advisors. “I like to tell folks when we first start an engagement, ‘My job is to ask the tough questions now.’”

“The day they think about retirement generally is the day before they retire,” says Mike Lynch, managing director at Hartford Funds. “I think we as financial professionals can really help in identifying those folks and starting the conversation now.”

Sizing up the business and the plan

To start, advisors can push for answers on whether they plan to sell the business or keep it in the family. Getting an answer to these questions can be complicated, requiring clients to think about succession planning, family dynamics, or the impact on the local community and customers. In short, don’t expect easy answers.

“There’s a lot more to unpack on the business side that oftentimes doesn’t get dealt with,” Brownell says.

If the owner intends to sell, it’s essential to get an expert quote from a third party. Given how the business is often the largest asset in a business owner’s portfolio, it’s critical to come up with a realistic estimate, so the retirement plan doesn’t have an unexpected shortfall. This is a common blind spot for business owners.

“Most business owners are optimistic … they feel very strongly about the business. But the business is not worth what they think it’s worth. That’s kind of the cold, hard, objective truth,” says Brownell.

Ideally, advisors start working with business owner clients a few years before they intend to exit the business. “That gives us time to catch things up and make it look good. It’s just like selling a house. The business needs to be renovated; it needs to be upgraded. You wouldn’t expect to get top dollar out of a house if you still had a kitchen from the 1970s,” he says.

Supplementing and diversifying

If the sale of the business isn’t enough to fund retirement, or if the client intends to keep the business in the family, then advisors need to make sure that they’re budgeting to fund that retirement account every year — whether through a 401(k), a simplified employee plan individual retirement account, brokerage account, trust or another vehicle.

“Advisors can really add a lot of value in thinking through those types of things. These are really good ways to add value outside of the business,” says Brownell.

For instance, clients that might have neglected retirement savings for a couple of decades but have a business that yields a lot of positive cash flow can catch up quickly through a cash balance plan.

Other areas to consider include life insurance. For small business owners, especially one in a partnership, life insurance can mean the difference between having a business fold or survive. A life insurance policy can also be used as collateral to get a loan from the bank.

If a business includes real estate, it may make sense to separate the real estate into a separate entity, Brownell says. One reason is that it’s challenging to sell both a business and real estate. Another reason is that holding on to commercial real estate can create an income stream in retirement. An owner could sell the business, then lease that commercial space to the next owner.

If the anticipated liquidity event is enough to cover retirement, then the advisor needs to help the client diversify and turn the capital into assets that will fund the client’s lifestyle for as long as necessary. A diversified portfolio along with annuities and life insurance could all play a role.

These days, more and more baby boomers are rethinking the idea of retirement. Small business owners who don’t want to retire at a certain age are finding more ways to continue working, even remotely. Retirement plans, like life, can change. Advisors who can help clients develop a plan and then be there to help tweak and support as needed are valuable to clients.

“You don’t have to cure everything for everybody or be an expert in every area, but really listening and then pointing them in the right direction — I think it’s going to be a value as we move forward,” says Hartford Funds’ Lynch.

Next: Retirement: When the Best Laid Plans Go Awry

Previous: Death, Taxes… and Annuities?

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