The COVID-19 pandemic inflicted unforeseen hardship on countless businesses across New York state and beyond, causing many business owners to tap into personal savings or retirement accounts to endure the devastating economic fallout.
For many of these business owners, the impact of the pandemic forced tough decisions that have come at the cost of self-sacrifice to remain solvent. Depleting emergency savings, halting contributions to a retirement plan, not taking a paycheck, and lowering federal and state tax withholding are some of the common emergency tactics used by business owners over the last year to keep their businesses and finances as healthy as possible.
In an environment where prioritization was key to staying afloat, it has taken ingenuity, creativity, and a whole lot of grit to get through the current economic climate. As we cautiously turn the corner, it is time for business owners and leaders to devise a plan to start saving again for retirement and to replenish personal losses.
Understand retirement needs
Gain a clear understanding of how much money you will need to live on in retirement, especially when your business is no longer picking up the tab for some expenses. Sit down, consider your lifestyle, and determine what that top-line number is to support your needs down the road. Your priorities may have shifted over the last year, so now’s the time to take that second look and see what holes need to be filled.
Many small-business owners view the sale of the business as their retirement plan. And that’s more than a little troubling, given only a fraction of America’s entrepreneurs are properly prepared. Often, the plan is that, when they retire, they transfer the business to a family member in exchange for a share of the future wealth. Sometimes, they negotiate a buyout, or sell it off and turn that business into cash. This “all eggs in one basket” approach is dangerous for several reasons. Below are four ways business owners can ensure they have saved enough for retirement:
• Run your numbers to get a sense of what your living costs might be when you stop working. This could result in a wake-up call to create alternative saving vehicles.
• Hire a financial advisor who will partner with you to review all the pieces of the puzzle. Advisors and planners will help you devise a financial plan, which encompasses retirement, protection, and estate planning. For business owners, this can be especially complex given succession planning and what happens to the business after the owner retires.
• Start a diversified retirement plan, such as a SEP-IRA, SIMPLE IRA, Solo 401(k), or SIMPLE 401(k).
• Keep it simple. Invest in a target-date fund that automatically adjusts the balance of your fixed-income investments and stocks based on your age. Select the target-date fund based on the age you expect to retire.
Replenish emergency savings
If this last year has taught us anything, it’s that businesses need an emergency fund. Changes in the economy, regulation, or the tax landscape can result in financial instability for a business, which can be daunting without a safety net. For small businesses, it can be challenging to find resources to stash away. However, there are some ways to sock money away without considerably impacting cash flow.
• Keep at least 10 percent of annualized revenue in the bank
• Build unanticipated expenses into your projected profit/loss
• Save larger amounts during prosperous times
• Know how much you will need to keep running in a crisis
• Continually reevaluate monthly operating expenses
• Transfer a small amount from each transaction into savings
• Automate savings
• Anticipate slow periods based on seasonal revenue
• Forecast high
Start a diversified retirement plan
This is where you, as a business owner, can lead yourself and your employees on a path to financial recovery. You do not need to max out contribution limits, 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 relatively small. The four main options are 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 or a Simplified Employee Pension is a retirement plan for small business with one or more employees. You, the business owner, count as an employee. One of the best features of this specific type of retirement account is that it can be set up and funded between year’s end and your tax-filing deadline. The SEP is funded pre-tax, which means you will get a tax deduction at the time of contribution. However, taxes will be owed when you make a withdrawal from your SEP-IRA.
• A SIMPLE IRA is a retirement plan for owners with 100 or fewer employees. Contributions are pre-tax and taken directly out of employee’s paychecks, similar to a 401(k).
• A Solo 401(k) is for self-employed people without employees (except perhaps a spouse). One of the potential benefits of a Solo 401(k) is the flexibility to choose when you want to deal with your tax obligation. To understand Solo 401(k) contribution rules, you want to think of yourself as two people — an employer and an employee. The contribution limit for 2021 is $58,000, with an additional $6,500 catch-up contribution if 50 or older. Within that overall $58,000 contribution limit, your contributions are subject to additional limits in each role. As the employee, you can contribute up to $19,500 in 2021, or 100 percent of your compensation, whichever is less. As the employer, you can make an additional profit-sharing contribution up to 25 percent of your compensation or net self-employment income, which is your net profit less half of your self-employment tax and the plan contributions you made yourself. The limit on compensation that can be used to factor your contribution is $290,000 in 2021.
• A SIMPLE 401(k) is for a business with 100 or fewer employees. Plans combine the features of a traditional 401(k) with the simplicity of SIMPLE IRAs. SIMPLE 401(k) plans work more like a traditional 401(k), but employees’ contributions are capped at the lower annual amount. Under a SIMPLE 401(k) plan, an employee can elect to defer compensation. But unlike a regular 401(k) plan, you, the employer, must make either a matching contribution up to 3 percent of each employee’s pay, or a non-elective contribution of 2 percent of each eligible employee’s pay.
It’s important to remember that retirement planning and economic recovery are unique to each individual business owner, but there are some general rules of thumb that can be helpful across the board. With proper planning and strategic financial moves, the path to financial recovery is in sight.
Jennifer Green is a VP and senior wealth advisor with Tompkins Financial Advisors in the Fayetteville area. Contact her at JGreen@tompkinsfinancial.com or (315) 720-8017.