Business Owners Dream (Wrongly) of an Easy Retirement Transition

Art by Amy Matsushita-Beal

Jeff Crandall, with the Crandall Law Group in Hayden, Idaho, is a business, real estate and estate planning attorney with nearly 30 years of experience. In that time, Crandall has worked with many small business owners as they prepare for and transition into retirement.

To put it simply, Crandall says, there is a major lack of preparation among the small business community when it comes to preparing for the retirement transition and the succession of business ownership. “Owners of businesses, like employees and everyone else, want to make sure they will have enough money in retirement,” Crandall tells PLANADVISER. “Business owners believe strongly in the value of their businesses, so they are often tempted to reinvest everything into the enterprise, thinking that will be their retirement plan. For a variety of reasons, this might be a mistake.”

Severe Lack of Preparation

In Crandall’s experience, the vast majority of business owners have not taken any of the steps that can help to make an easy retirement transition a reality. “They are looking at the business as their nest egg and believing it will be a retirement funding vehicle,” Crandall says. “This isn’t a mistake in itself—the mistake is the lack of any real advanced planning for making this happen in an advantageous and efficient way. It’s unfortunate that most people in this business owner community don’t even have a personal estate plan, let alone a retirement transition plan for their business.”

Writing previously for PLANADVISER on this topic, Cathy Clauson, senior vice president of retirement solutions at AssetMark, noted that the amount of income gained from selling a business is far from guaranteed, which creates an opportunity for advisers to help clients diversify business owners’ retirement strategies for long-term security.

By having a frank conversation about a client’s retirement plan and demonstrating the value of a market-based and risk-conscious approach, advisers can help their clients avoid the potential repercussions of putting all the eggs in one proverbial basket.

“It’s something financial advisers should talk about,” Crandall agrees. “Advisers are on the frontlines for this kind of work and this kind of engagement with the client. If an adviser knows about this issue, they can help start the discussion much earlier. My role as an attorney comes later, as does the role of the certified financial planner.

The team approach can assist with coming up with the comprehensive plan.” In terms of practical advice to small business owners, the experts recommend starting to think about the mechanics of the ownership transition five or even 10 years ahead of the anticipated retirement date. Especially if one plans to sell their business to a third party, it takes at least five years of planning and formalizing such things as how the business’ profitability is measured, how the management structure is organized, how the taxes will be paid, etc.

“Again, the team approach works best,” Crandall says. “The tax adviser can play their role, and the CPA can be looking at the accounting and the books and see how everything has been structured for purposes of maximizing the transaction value, especially when it’s a third part sale. When looking at a family transition, that may be a different situation. But generally speaking, it’s best to set everything up as if you are going to be selling to a third-party, because at the minimum, you are at least going to be able to get an accurate valuation, which you would want to use for family purposes as well.”

Multiple Baskets

Rather than placing all their eggs in one basket, Crandall says, it makes sense to have some “backup” strategies in place. To this end, there are many retirement account options open to business owners. Although the number of options can make things confusing, Crandall admits, a tax and financial professional can often quickly make a recommendation, given their expertise. “For example, you may consider opening a 401(k), SEP-IRA, SIMPLE, or pension plan,” Crandall says. “This can reduce your income taxes now, while simultaneously placing some of your wealth outside your business.

From a financial perspective, these accounts are tax-deferred, so the investment growth avoids taxation until you retire, which greatly boosts returns.” The “best” plan for a given small business owner will depend on how much income their business earns, how stable their earnings are, how many employees they have, and how generous they want to be with those employees.

“You must consider how generous you’ll be with employees because the law requires most tax-deferred plans to be ‘fair’ to all employees,” Crandall warns. “For example, you can’t open a pension or 401(k) for yourself only and exclude all of your full-time employees. When making this decision, consider that many employees value being able to save for their retirement and your generosity may be repaid with harder work and loyalty from the employees.”

Owners can also consider contributing to an individual retirement account (IRA) or a Roth IRA. This can allow them to add more money to the retirement basket, especially if they have maximized their 401(k), SEP, or SIMPLE plan contributions.

Crandall’s firm further recommends that, if a small business owner is relatively young and healthy or otherwise an infrequent user of health care services, they could consider using a high deductible health plan (HDHP) and a health savings account (HSA) to add additional money to their savings.

Remember the Employees

In her column on small business owners’ retirement preparations, Clauson also spoke to the importance of considering employees’ needs as well. “While some may believe they don’t have the resources to offer a retirement plan for their business, advancements in technology and the support of third parties can simplify the process of implementing a comprehensive retirement plan,” Clauson said. “The process of implementing an employee retirement plan doesn’t have to be prohibitively costly for small business owners. Employees will be contributing to their own retirement funds, and even plans that do not offer employer matching financially benefit staff through pre-tax savings.”

Firms that do have the capability to offer matching programs can also reap the benefits of these very same pre-tax incentives, Clauson concluded. Moreover, she recommended, employers should consider providing a company-wide retirement plan as a strategic investment in the firm’s productivity and bottom line, given that offering competitive employee benefits can be a crucial differentiator when it comes to attracting and retaining top talent.

The Importance of Estate Planning

“It’s critically important to have estate planning in place, because there are so many planning options that we can use to make the transition easier and more efficient,” Crandall says. “We encourage our clients to have a true family legacy plan that goes beyond simply defining who is going to be in charge of the business and estate if the owner dies, and how everything is going to be divide up.”

Crandall notes that people who don’t even have a will in place are stuck with succession provisions in the law that state that, when a person dies and has no will, the state simply divides up the deceased person’s assets amongst the closest hairs, equally. “That might be totally inconsistent with the parents’ plans for how they want the estate to pass to the next generation,” Crandall says. “Also, in that situation, the division of the estate would be considered a taxable distribution, and the tax consequences can be dramatic.”