Business owners and retirement planning: Key considerations

Business owners pose a unique challenge for financial advisors when it comes to retirement planning. With their often highly concentrated wealth and entrepreneurial mindsets, business owners don’t fit neatly into the standard retirement planning strategies advisors use for typical 401(k)-invested, nine-to-five workers.

The first step, and challenge, of retirement planning for business owners is getting the client to think about it in the first place, according to Mitch Hamer, founder and lead advisor at Chicago-based Intersecting Wealth.

“Typically, when you have a business owner client, all the conversations are about cash flow, meeting payroll, like trying to optimize as much as you can month to month or year to year, you know,” Hamer said. “So you’re really thinking in the moment. And there’s a behavioral psychology aspect that keeps folks sort of in the present.”

In some cases, business owners can launch, scale and sell a business all before meeting with an advisor to start talking about retirement, Hamer said.

“We’ve seen clients come in post-sale of a business or exit that had done zero retirement,” Hamer said.

From one business owner to the next, finances are far from uniform. But, advisors like Hamer say, it’s helpful to start with the big questions before getting into the client’s unique situation.

“When you’re a business owner, you really have to do a lot of goal setting early on to say, ‘OK, I’m very comfortable with two or three years of cash flow in case X, Y or Z happens … So [retirement planning requires] zooming out and really thinking behaviorally, psychologically and like, ‘What are my goals? What do I want to achieve?”

Building wealth in a new way

For business owners, investing often means one thing: putting money back into the business. Advisors say that while that strategy can reap major benefits for the business, it may not necessarily be the right move when it comes to the owner’s own retirement.

“It’s really tough, because they’re right. Oftentimes, the best place for your capital is in your business. And that’s true until it’s not,” said Luke Neumann, director and wealth manager at Boston-based Crestwood Advisors.

The question is: best for what? The old adage that concentration builds wealth and diversification preserves it is especially salient for business owners, many of whom have a majority of their net worth tied to their businesses.

“Concentration is not something necessarily to be afraid of, right? It’s something to lean into if you’re interested in building wealth,” Neumann said. “That said, once you get to a certain level, you obviously want to be taking steps to diversify once you have some kind of degree of success in business.”

Exactly what that diversification looks like can vary from one client to another.

For lone entrepreneurs or couples who both earn income from a business, setting up a solo 401(k) can make a lot of sense, Neumann said.

“Let’s say it’s … a husband and wife partnership, and they make, net of taxes, $750,000 a year. And they’re spending $300,000. We take the $400,000 and we diversify,” Neumann said. “We’re not just buying equities. We’re buying fixed income. We’re buying investments that kind of balance the risk that happens [with a business].”

Solo 401(k)s are available to self-employed individuals or business owners with no full-time employees, allowing them to contribute as both employee and employer for greater tax savings and flexibility.

Keep in mind, it’s not always the case that a business presents the more volatile investment, according to Hamer. In cases where a business owner is looking to maintain rather than scale their business, investing some money more aggressively into the market can be a good idea.

For business owners in high-tax states, other investment options, like cash balance pension plans, can be especially powerful.

“You’re able to put a ton of money into these plans, on the order of, like, $150,000 to $175,000 a year, pretax money into these cash balance pension plans,” Neumann said. “So we’ve been working with clients to develop those for small businesses. Great way to save, especially when you’re in a high-tax state. You can compare those with a solo 401(k) in most instances as well.”

A better business exit means a better retirement

Inevitably, a large portion of a business owner’s net worth will only become available for retirement planning during a business sale or exit. Given that fact, advisors say it’s crucial to take a strategic approach to an owner’s exit to maximize retirement outcomes.

For Neumann, that means asking questions like: Who’s the buyer of that business? How much can you expect? And what steps can be taken today to make the business more attractive to that eventual subset of buyers?

“There’s probably never been more capital in private markets chasing mid-size businesses that are attractive to private market investors. And this is absolutely a theme we see in our client base these days, whether that’s kind of a strategic buyer, or simply some kind of private equity firm looking to make a current turnaround on this investment.”

The task for business owners and the advisors working with them is figuring out what kind of exit they want to begin planning for. Selling a business outright to interested competitors or private equity firms is a viable path, but it’s not the only one.

“In the past year, we have worked with clients who have set up essentially a partnership in their small business, 100% owned by the client,” Neumann said. “Now they’re bringing in partners who are formerly employees who are now partners and owners of the business. And the idea is there’s a long-term transition plan. That’s a very viable path for small businesses to go down.”

“These carry benefits and costs, but identifying what the right transition plan is, and how that kind of affects you, is super important,” Neumann added. “And the earlier you start planning that from your eventual transition date, the more likely it is that you’re going to have a successful exit.”