By Rich Best
Unquestionably, business owners have the potential to generate significant earnings. However, because so many spend most of their time and money working in and on their business, they often have little left to invest specifically towards their retirement. Short of a well-conceived retirement plan with savings goals, they can face a steep climb with little margin for error in getting on track for their retirement. Early mistakes made in their retirement planning can compound into bigger obstacles along a shrinking time horizon.
Retirement Savings Mistake #1 – Not Saving Early and Often
Granted, it’s difficult for new business owners to envision their retirement, let alone plan for it as they struggle to launch their business. However, it’s never too early to start saving, even without a retirement plan. The most important financial concept young business owners need to understand is the “time value of money”. The sooner they can start saving, the longer that time and the miracle of compounding returns will be able to work their magic. Consider the results of saving just $500 a month starting at age 25 versus age 35 – a ten year difference:
$500 per month savings assuming a 6.5 percent annual return
|Age to start saving||Accumulated capital at age 65|
Source: Bankrate.com™ Simple Savings Calculator
Under these assumptions, with just a ten year head start, it’s possible to double the outcome, which makes not saving early a very costly mistake.
Retirement Savings Mistake #2 – Not Saving Enough
In retirement planning there are certain rules, formulas and guidelines that have been established over time to help us determine how much we should save for retirement. The “15 percent” guideline told us we should save 15 percent of our earnings. The “4 percent rule” says we need to save enough to be able to draw down 4 percent of our assets each year in retirement. The “70 percent rule” says we only need 70 percent of our working year’s earnings to live in retirement. While these rules are helpful for getting us on the right trajectory, they’re generally based on some outdated assumptions, and in this “new normal” environment, may not fit quite so snugly. In retirement planning, relying on outdated assumptions could lead to saving too little, which, if discovered too late, could be disastrous.
The only factor any of us can control over time is the amount of money we can save right now, which also becomes the most reliable strategy we can follow. Business owners have a better opportunity to save a greater amount than any of these rules imply.
It may be difficult, after extended, delayed gratification, but the best course new business owners can follow is to live on a strict budget that targets a minimum 15 percent savings rate that can climb to as much as 25 percent. For established business owners, the best course would be to cap their lifestyles and even begin to downsize in their peak earning years to layer on additional savings.
Retirement Savings Mistake #3 – Saving in the Wrong Vehicles
If you manage to avoid mistakes #1 and #2, you are more likely to do well accumulating the capital you need to create lifetime income sufficiency. However, the income generated by your assets can be significantly reduced by taxes, which can impact sufficiency. While it might make sense to take advantage of the tax advantages of your qualified retirement plan, it’s important to note that withdrawals from these plans will be taxed as ordinary income.
The better course may be to diversify your taxes now in order to maximize your income later. Instead of plowing all of your savings into tax-qualified vehicles that give you a tax deduction today, you should consider allocating your savings among vehicles with varying tax treatments today and in the future. For example, tax-free vehicles, such as tax-exempt bonds or a Roth IRA, can generate tax-free income at retirement. Long-term investments held in a non-qualified account can accumulate capital that will be taxed at a more favorable capital gains tax rate.
By employing a tax diversification strategy today, you can exert more control on the amount of taxation at retirement when the need to maximize your income is the greatest.
Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice. Any views expressed in this article may not necessarily be those of Nevada State Bank or its affiliates.