Employment disruptions caused by the COVID-19 economic slowdown have scrambled the retirement saving strategies of many Americans. According to a recent survey, nearly half of employed Americans either reduced or suspended their retirement savings during the pandemic.
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Many business owners procrastinate putting a well-conceived succession plan in place. The reasons are understandable. It can be difficult to plan for your replacement and deal with your mortality.
Here are five of the top reasons why business owners don't have an exit strategy, along with the reasons why it's best to make a proactive plan.
Reason Number 1: No Time. Business owners are busy with the day-to-day tasks involved in running their companies. There are deadlines to meet and deals to be made. Succession planning can be done ... later.
Why this thinking is wrong: Waiting too long can cause the outcome to be less beneficial to the owner and his family. If a rushed decision is made, the owner may get a low price or pay more in taxes than he or she would if adequate planning was done. And in a worst case scenario, "later" may never come. An unexpected death or disability might result in succession occurring sooner than expected and without a solid plan, the future of the business can be placed in jeopardy.
Reason Number 2: Loss of Control. In some cases, business owners may not want to stop working for the companies they spent years building. Giving up control is difficult. Owners may worry they will be bored in retirement or their companies will no longer flourish if they are not in charge. So they hang on.
Why letting go is a better approach: The most successful exit strategy takes months or even years to complete. With proper planning, you may be able to secure a position after the sale as a consultant. If you want to pass on the business to your children or grandchildren, you can be involved in training them to help them achieve success. In other words, a proactive approach brings more control over the end result.
Reason Number 3: Ignoring Tax Issues because they are Complex. There are obviously a number of ways to structure a succession transaction. The most tax-efficient way depends on the company, the parties involved and when you sell (federal tax capital gains rates may increase in the future). The tax implications of a sale or transfer can be extremely complex.
Why it's best to get professional tax advice: You have to make several decisions that will affect the tax bill, such as whether to sell assets or stock. Your company may wind up with unknown, costly liabilities if the transaction isn't structured properly. Handling the sale in a tax-wise manner can save you a fortune in the long run -- not only with income and capital gains taxes but also with estate and gift taxes. Consult with your tax adviser well in advance of the actual sale.
Reason Number 4: Not Sure Who Is Going to Take Over. For many owners, there is not a clear-cut successor. Are there partners? Should you sell to employees via an Employee Stock Ownership Plan (ESOP)? Sell to a third party?
In the case of a family business, there are even more questions. What if some children are active in the company and others are not? Which child is going to run the company? Does the "heir to the throne" have the business skills to succeed? Will a formal succession plan cause family conflict?
Without all the answers, a business owner may do nothing.
Why this is a mistake: Without a solid plan, the company you spent years building could cease to exist. There are many options for ownership transfer. You can sell outright, sell to your children, gift interests to family members at a low tax cost -- and more. But if you don't explore the possibilities, you leave the outcome to chance.
Reason Number 5: Not Enough Retirement Savings. While building their businesses, many owners put off making adequate contributions to retirement plans. The result may be insufficient savings. Where is income going to come from during retirement -- especially if the owner wants to pass the company onto family members? Often, there is a conflict between wanting comfortable golden years and wanting to transfer the company to heirs as part of an estate plan. So the owner just keeps working.
Why continuing to work without a succession plan is a mistake: By planning ahead, you can take care of your retirement and your heirs. With certain financial strategies, you may be able to retire comfortably and plan for the eventual sale or transfer of the company.
These are just some of the reasons business owners procrastinate and why they need to have proactive exit strategies. Start well in advance. Assemble an advisory team that includes your accountant, estate adviser, corporate attorney, and possibly other professionals.
And if transfer your business to your children, urge the next generation to start thinking about their succession plans.
If you want a retirement plan for your small company or self-employed business -- but you don't want to be buried in paperwork -- consider a simplified employee pension plan or SEP.
Among the appealing advantages:
Despite the Advantages, there Are a Few Downsides:
1. SEPs are set up by simply filling out a brief form.
2. Annual reports aren't required to be filed with the IRS, although you must provide a copy of the SEP form to each covered employee. (Most retirement plans require detailed reports to be filed with the IRS and the Department of Labor.)
3. Contributions can go from zero to the maximum each year, so if your company has a bad year you can skip the contribution.
4. SEPs allow for "look-back" contributions. As an example, you can make a SEP contribution, up until the date you file your tax return (including extensions), and deduct that contribution on that tax return.
5. Employees make their own investment decisions. All SEP contributions are fully vested and portable. In fact, SEPs are sometimes referred to as SEP-IRAs. The maximum contributions are 25 percent of compensation for employees, or 20 percent of self-employment income for sole proprietors, partners and LLC members. The absolute maximum amount that can be contributed to an account and deducted is $52,000 for 2014 (up from $51,000 in 2013).
All in all, if you are a small corporation or self-employed, the ease of a SEP may simplify your life and help fund your retirement. Consult with your tax adviser for more information.
All of the SEP funding comes from you. And you may have to contribute on behalf of employees that you'd like to exclude.
If you have a large, relatively high-paid work force, sponsoring a SEP can be expensive.
There is 100 percent vesting right away so you have little or no control over what each employee does with the money. If a staff member wants to take out their funds prematurely and pay the taxes and penalties right away, you can't prevent it.
In a well-known Aesop's Fable, ants stockpile food during the summer bounty, while the grasshopper sings and plays. When winter sets in, the grasshopper starves. The moral of the story is to work hard and plan ahead. In modern times, this lesson can be applied to retirement planning.
What Else Does the Fed Survey Reveal About Household Finances?
The Federal Reserve's Report on the Economic Well-Being of U.S. Households in 2013 provides a "snapshot" of how U.S. households are faring financially. It monitors their recovery from the Great Recession and concerns, including:
Financial well being. The recession took its toll on many households, with 34 percent saying they're worse off financially than they were five years ago. Although more than 60 percent of households are "doing okay" or "living comfortably," a quarter are "just getting by" and more than 10 percent continue to struggle.
Home values. Among people who had owned their homes for at least five years, 45 percent reported that their home values were lower than in 2008. However, homeowners were generally upbeat about the 12-month outlook for their local housing markets.
Savings. The recession depleted savings for many people. About half of households currently maintain a savings account, but only 39 percent believe their rainy-day funds could cover three months of expenses. One-fifth of households routinely spend more than they earn each month. And only 48 percent could pay a $400 hypothetical emergency expense without selling something or borrowing money.
Financing. More than 40 percent of respondents delayed a major purchase and nearly 20 percent postponed a major life decision during the recession. This was at least partially due to limited financing opportunities. The availability of credit remains a concern for most people. One-third of credit applicants were turned down or given less than they applied for. Many people (19 percent) didn't bother applying for credit for fear of rejection.
Student loans. Nearly a quarter of households are carrying education debt incurred by themselves or their spouses, partners, or children. The average student loan debt is $27,840. Some households struggle to pay this debt, especially if they failed to complete the educational programs. In fact, 18 percent of student loan holders are behind on payments.
Are You an Ant or a Grasshopper?
Unfortunately, many Americans behave more like grasshoppers than ants when it comes to stockpiling money to pay their living expenses during retirement. About one-third of non-retired Americans have no retirement savings or pensions, according to the Report on the Economic Well-Being of U.S. Households in 2013, which was recently published by the Federal Reserve. Almost half of the survey's respondents aren't actively thinking about financial planning for retirement. A quarter of those adults with retirement savings are uncertain exactly how they'll make ends meet during retirement.
Note: The responses varied with age, education and income-levels, however. Not surprisingly, higher-income individuals are the most likely to plan for retirement.
Retirement accounts were hard-hit when the markets collapsed beginning in 2007 -- and many haven't fully recovered. For example, the Standard & Poor's index lost 55 percent of its value between October 2007 and March 2009.
During the recession, many Americans put retirement saving on the backburner -- or took early withdrawals from retirement accounts to pay current bills. In the aftermath, two-fifths of those ages 45 or older have postponed their planned retirement dates due to insufficient savings. Of those between the ages of 55 to 64 who haven't yet retired, 24 percent plan to work as long as possible.
On the other hand, 19 percent retired earlier than expected during the recession, due to involuntary layoffs or company-sponsored early retirement plans. This means their retirement funds will need to last longer than they originally anticipated.
Traditional Sources of Retirement Income Fall Short
Many people expect Social Security to be a major source of retirement income. But Social Security checks are often lower than recipients expect -- and may be hit with taxes, especially if you have other employment or investment income. Check out the online benefits calculator on the Social Security Administration website for details on your projected payments post-retirement.
In addition, fewer Americans are members of defined-benefit pension plans these days. From 1980 through 2008, the proportion of private wage and salary workers participating in defined-benefit pension plans fell from 38 percent to 20 percent, according to the Social Security Administration's Office of Retirement and Disability Policy.
So it's more important than ever to be proactive about stockpiling money for retirement. You also need to be realistic about cost of living increases and build in a cushion for emergencies and unexpected costs when projecting the income you'll need in retirement.
For example, many retired Americans were unprepared for recent increases in the costs of utilities and gasoline. Other expenses -- such as Internet and cell phone accounts -- didn't exist when some of today's retirees made their initial plans. Americans are also healthier than past generations, living longer and incurring higher-than-expected medical expenses.
Advance Planning Can Avert Shortfalls
A financial adviser can help you plan far in advance to build up a nest egg that will provide sufficient income to maintain financial security for potentially many years. In addition to Social Security and pension benefits, here are other common sources of retirement income:
Self-directed accounts, such as company-sponsored 401K plans and individual retirement arrangements (IRAs);
Home equity; and
Part time or self employment.
A part-time job in the early years of retirement can make a big difference to your financial picture. Earning even $4,000 a year replaces the income you could reasonably expect to generate from a $100,000 portfolio. It also provides a buffer against unexpected inflation. The flip side of this coin is that it might be difficult to find a job as you grow older and, of course, work doesn't appeal to all retirees. Poor health can also render some people physically unable to work into retirement, so it's always smart to have a Plan B.
Retirement saving strategies need to be designed with your age, relationship status, lifestyle, minor children, and other heirs in mind. Whether you're starting your first job or hitting middle age, savings patterns are likely to change. By the time you near or hit retirement age, investments and savings should be set and established, with your funds in low-risk, high-liquidity accounts.
It's Never Too Late to Save
Individuals who are age 50 or over at the end of the calendar year can make annual catch-up contributions to certain accounts, if their retirement savings seem too lean. Here are some of the contribution limits in 2014:
Traditional and Roth IRAs, $5,500 ($6,500 for those over age 50),
401(k) accounts, $17,500 ($23,000 for age 50 and up),
SIMPLE accounts, $12,000 ($14,500 for age 50 and up), and
Simplified Employee Pension Plan (SEP) accounts, $52,000 (there is no SEP catch-up amount).
Whenever possible, it's a good idea to contribute the maximum allowable to your retirement account to secure your future and get the full tax advantage.
What's Your Retirement Plan?
If you haven't saved much for retirement or stopped contributing during the recession, it's time to get your plan in motion. If you already have a plan in place, consider revisiting it occasionally. A retirement plan isn't something you can put on a shelf and ignore until you reach age 65. You may need to revise your initial plan as market conditions, tax laws, financial needs or health factors change. Contact your financial adviser for more information.