Preparing for Your Retirement While Owning Your Own Business
Retirement Plans: Taking Care of Your Own Financial Security
Retirement planning can be challenging, but for small business owners, this process can be more cumbersome. While employees can focus primarily on their individual paths toward retirement, you have to be concerned about the future success of your business in addition to your own financial security in retirement. Why? Because more often than not, these two things are intertwined. For many business owners, their company is their primary investment. Consequently, they can't afford to retire because they are relying on the continued success of the business to financially sustain them during their retirement years.
If you fall into the "not planning to retire" category, you're not alone. However, as you get closer to age 65, the idea of retiring may sound more appealing. So how can you cash in on your business when it comes time to retire? A combination of retirement strategies may be your best approach.
Qualified Retirement Plans: Enjoy Tax Deductions Now & Pay Taxes Later
You likely know the value of all applicable tax deductions for your business. Unfortunately, federal law only allows deductions for contributions to certain tax-qualified plans. Qualified plans involve pre-tax money and tax-deductible contributions; you pay taxes later on the withdrawals that you make. Non-qualified plans, on the other hand, involve the deferral of current compensation and gains on such compensation until paid out. Qualified plans have required minimum distribution (RMD) requirements, but non-qualified plans do not. If you have a qualified plan like a traditional 401(k) or individual retirement account (IRA), the IRS requires you to begin withdrawing money (RMD) by April 1 of the following year after you reach age 70 1/2.
Qualified tax-favored retirement plans include defined benefit pension plans, money-purchased pension plans and 401(k) plans. All of these plans allow for tax-deductible contributions and tax-deferred growth, but their benefits come at a price. Federal law mandates which of your employees must be covered by the plans, limits the amount of money you can set aside for yourself, and restricts the investment choices within the plans. Also, if you are a highly compensated individual, you are limited by the amounts you can contribute to qualified plans, restricting your ability to accumulate money on a tax-favored basis.
Non-Qualified Retirement Plans Can Give You More Freedom
Non-qualified retirement plans may be a better retirement income solution for you. They enable you to direct retirement benefits exclusively to yourself, family members working in your business and/or certain key employees. They give you the freedom to direct dollars at your discretion with few limitations and minimal administration. There are four basic non-qualified retirement plan arrangements:
Executive Bonus -- Simple to implement and easy to administer, executive bonus arrangements can provide you and your family with life insurance benefits, including tax-free retirement income and death benefits. You personally own the life insurance policy and name your own beneficiary; the business does not own any interest in the policy. Your business then pays the premiums, and the dollar amount for the premium is added to your taxable income.
Split Dollar -- A split dollar arrangement is a way to use business dollars to pay part of the cost of a personally owned life insurance policy.
Executive bonus and split dollar arrangements both involve payment of additional income to you from your business. If you want to reduce your current income for tax reasons, a deferred compensation arrangement may be the solution.
Deferred Compensation -- These arrangements simply allow you to defer some or all of your regular compensation to a later date. If properly structured, a deferred compensation arrangement allows you to avoid income taxation until the deferred amount is actually received. Ideally, you would be in a lower tax bracket when you receive this retirement income.
Salary Continuation -- Salary continuation arrangements work the same way as deferred compensation except income is promised without the reduction of current compensation. Benefits to be paid to you are set out in a deferred compensation written agreement. Obviously, the continuation of your business through your retirement is crucial to the success of this arrangement. Life insurance may be used to informally fund the promised future benefits. In this case, the life insurance is owned by the business (which is also the beneficiary), so cash values are business assets, and death benefits are received by the business.