Six Tips Business Owners Can Use to Build a Strong Retirement Plan
When it comes to retirement planning the most common question we hear from clients is, “Are we going to be OK?” It’s not always an easy question to answer. No one knows what the future holds, but we do know that thinking ahead and making a plan significantly improve your odds of having a comfortable retirement.
The single biggest key to success is getting in the habit of spending less than you earn. Consistently living beneath your means is the only way to save enough to build up a nest egg that will last longer than you do. The general rule of thumb is that you should be able to afford to withdraw 4% of a well-diversified portfolio’s value annually and have that support you no matter how long you live.
With that foundation in place, your chances of a comfortable retirement are very good. To make them even better, we offer these six tips for making the most of what you save:
1. Take Advantage of the Right Combination of Investment Vehicles for Your Situation
Depending on your tax bracket and other considerations, you should consider a 401(k) or other tax deferred qualified plan, an IRA, a Non-Deductible IRA – or some combination of those options to protect and grow your investments.
A 401(k) may be the most beneficial to those earning a high income since it allows you to defer tax to retirement, when you’re likely to be in a lower bracket. If you’re a big earner and/or a big saver, you’ve probably stashed the maximum contribution the IRS allows into your 401(k) and you’ll probably want to also contribute to an IRA.
A non-deductible IRA may be a good option for savers who have maxed out their annual 401(k) contributions or are otherwise ineligible to contribute. While the contribution to a non-deductible IRA does not reduce your taxable income in the year you contribute, it defers any tax on investment growth until you begin to make qualified distributions (generally between 59 ½ to 70, with some exceptions).
2. Consider Contributing or Converting to a Roth IRA
With a Roth IRA you invest after-tax dollars but when you make qualified withdrawals in retirement, you may pay no tax. Funds may be withdrawn tax free and your investment grows entirely tax free. This approach may be a good idea for someone who is in a lower tax bracket now than they will be in retirement – typically this would be someone at the beginning of their career, not at the height of their earnings potential.
Determining the right IRA for your situation requires careful consideration of a variety of variables specific to your particular situation. Smith & Howard Wealth Management can help you choose wisely.
3. Manage Health Care Costs
The most challenging expense to manage in retirement is health care. It can be extremely expensive and even more so if you don’t have the right coverage. In some cases, you may spend a large portion of your nest egg on health expenses.
Retiring before 65
Be aware that if you retire before age 65, you won’t have access to Medicare until you reach 65. If you’re in that boat, you have two options:
- COBRA. If your business had a health plan, you can continue to be covered on that plan, but all premiums become your responsibility and these can be very significant. COBRA has a maximum coverage period of either 18, 29 or 36 months.
- With a qualifying event, one can enroll in coverage through the Affordable Care Act (ACA). Each November, enrollment opens for coverage for the following year.
One important note: make sure any health plan you sign on to is ACA compliant. Policies that aren’t may have coverage limitations and benefit maximums that put the financial onus on you in the event of a catastrophic health issue. For example, if your policy has a limit of $100,000 and you are in a bad accident, your costs can easily exceed that limit. As another example, the costs of treatment for cancer or its reoccurrence could outstrip the benefit maximum of a non-compliant policy.
Retiring after 65
If you are 65 or older and have retired, there are three critical steps you need to take to keep your health care costs in check:
- Apply to both Medicare Part A, which covers your hospital expenses, and Part B, which covers general medical expenses. Putting off this task can result in higher premiums.
- Determine if a Part B supplemental policy makes sense for you. Since Medicare only covers 80% of accepted general medical claims, it probably makes sense to pay for a policy to cover the remaining 20% with a Medigap policy.
- Apply for Medicare Part D, which covers prescription drugs.
4. Protect Your Investment in Your Company
Business owners invest time, energy and money in the life of their business. The loss or diminishment of each of these prior to or at retirement can have a damaging effect on your retirement nest egg. Among the key areas we work with business owners on during retirement planning are these:
- Life and disability insurance / buyout agreement
- Liability policy and errors and omissions
- Succession planning
Life & Disability Insurance / Buyout Agreement
A buyout agreement seeks to protect businesses and their owners when another owner wants to leave or retire. If a co-owner passes away pre-maturely or becomes disabled then a business can use a life or disability policy to provide liquidity for payment of company stock. There are several other benefits to the business when having a solid plan in place. The business may become a better credit risk and provides the business continuity.
Business owners should take care to have adequate coverage on their real property, contents and liability. Premiums may be deductible. Business owners may also need a commercial umbrella policy. The premiums may also be deductible. Finally, some business owners or professionals should have professional liability coverage that suits their situation. This would cover areas such as errors and omissions, malpractice, or other general mistakes of a professional.
Another unnecessary risk some business owners take is not developing succession plans. Planning to pass leadership of a company to employees is a tough task but can ultimately make the business more valuable. Business owners may be able to take off additional burden as they delegate more tasks and responsibilities. We believe that strategic succession planning may make the business more valuable in the long run. This is another area where Smith & Howard Wealth Management can help.
5. Be Strategic About Early Withdrawals from Retirement Accounts
If you take money out of any IRA or 401(k) before you’re 59 ½, the amount you withdraw is added to your taxable income for that year and taxed at your current rate. In addition, you must pay a 10% early withdrawal penalty.
There are situations where the IRS will waive the penalty and these are listed below. It’s important to note though that even in these situations, early withdrawals are still taxed as ordinary income.
- College tuition
- First home purchase ($10,000 per person, $20,000 for a married couple)
- Unreimbursed medical expenses that exceed 10% of adjusted gross income
- Health insurance if you receive unemployment compensation for 12 consecutive weeks
- Disability if a physician determines your condition is expected to result in death or to be long, continued and indefinite
- In a difficult cash flow situation, if you’re at least 55, the IRS allows for what it calls “substantially equal payments,” which requires setting up annuity payments for a minimum of five years
6. Dealing with Required Minimum Distributions
If you’re 70 ½ or older, you must take required minimum distributions (RMD) from your 401(k) or IRA on an annual basis. This amount starts small – around 2% or 3% – and increases as you get older.
If you’re retired, there is typically no way to avoid RMDs, but you may be able to manage the tax impact. One way to do this – if you’re charitably inclined – is to make a qualified charitable distribution. This requires that you be 70 ½ or older and that the contribution is not in excess of the RMD. You may pay less tax if you receive the RMD funds and made the contribution from that sum.
If you don’t need to spend RMD, you can also re-invest. A tax-sheltered approach to reinvesting is to convert the funds to a Roth. Someone in the early stages of retirement with low taxable income can benefit from this approach. You pay the tax now and let the funds grow until needed.
Want to Learn More?
Tax laws are complex and every family has different needs and goals. The tips and strategies detailed in this article will work well for some and will be inappropriate for others. I’d be happy to answer any questions you may have or to sit down with you and help you develop a tailored approach to reaching your retirement goals. You can reach me here or at 404-879-3128.
About Smith & Howard Wealth Management: We are an Atlanta-based wealth management firm serving affluent clients since 1999. Our team of experienced, dependable and approachable experts serve as your family CFO, helping you make wise, well-informed decisions about your financial situation.