How To Establish Your Retirement Strategy

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Small business owners face a variety of retirement planning choices. So how will you select your retirement strategy?

We will discuss retirement planning, consider portfolio diversification, and demonstrate the importance of tax-sheltered growth.

“Hoping you will have enough money is not a retirement strategy. Doing nothing is not a strategy.”

Personal Finance, Garman/Forgue

Retirement Finance Fundamentals

  • Similar to other goals, you are more likely to be successful if you have a plan
  • Diversification is a key (don’t put all your eggs into one basket)

Retirement Planning

Take some time to determine what retirement might look like for you. Some considerations for exploration:

  • At what age you will retire?
  • How long you think you’ll live in retirement?
  • Where will you live? What is the cost of living there?
  • How much (and where) do you expect to travel?
  • If you will have kids/grandkids, what financial help will you offer to them (car, college, first home, etc)?
  • Do you plan to generate income from working during retirement?
  • Will you downsize your housing, upgrade, or stay put? Will your mortgage be paid off?
  • Do you expect to receive any Social Security benefits?

Using the answers to the questions above, estimate how much money you will need for your retirement. This is the total accumulated savings and investments needed to provide income for your desired retirement lifestyle.

Most retirement planning guides recommend that people plan for 70-90% of their pre-retirement income to maintain their lifestyle during retirement. Fidelity Investments recommends having ten times your final salary in retirement savings to retire at age 67.

Retirement savings targe as multiple of income Fidelity

Obviously, the retirement savings goals you set in your 20s may change over the years. But the important thing is to begin the planning process early:

  1. Begin with your retirement goals in mind
  2. Estimate your retirement savings goal
  3. Understand life expectancy and figure out how long your money will last
  4. Design your retirement strategy (blueprint) and a savings plan to reach your goal
  5. Start working the plan into your daily life
  6. Stick with it — Remember, you are playing the “long game” here!
  7. Periodically review your retirement plan and make adjustments

Here are links to a couple of retirement calculators to get you started:

“Three quarters of investors overestimate the safe withdrawal rate.”

Personal Finance, Garman/Forgue

Your Retirement Strategy

Choose an Investment Broker to Host your Retirement Accounts

If you are new to investing and would like to primarily be hands-off, a Robo-advisor like Betterment may be a good fit. First, you tell them your goals, timelines, and risk preferences. Then they will build your portfolio using Modern Portfolio Theory (MPT), which uses diversification to maximize your returns while minimizing your risk. Their management fees start at 0.25% annually with no minimum deposit. Their core portfolio consists of Exchange Traded Funds (ETFs) from 13 different asset classes, and their average expense ratio is 0.11%.

As discussed in a previous article, you want your retirement funds invested in low-expense options such as index funds and ETFs, so you might also consider Fidelity Investments or Vanguard. They specialize in funds and usually don’t charge any commissions on their own funds.

Note: We receive no kickbacks from any affiliates. Our independence ensures we are free of conflicts of interest.

Investment Vehicles

Personally Established Accounts Are Available to All. You may not have yet established a company retirement plan as a small business owner. And even if you have, you should also start your own retirement accounts to help fund your future. Individual Retirement Accounts (IRAs) are retirement investment vehicles that are widely available and extremely easy to set up.

Roth IRA (after-tax investment, tax-free growth, tax-free withdrawals)

A Roth IRA should be your default retirement choice if you qualify. Although it won’t help lower your taxes in the year you contribute, funds in the account grow tax-free. And withdrawals are also tax-free if taken at age 59 1/2 (or older) from an account held for five years. In addition, Roth IRAs have no minimum required distributions.

Traditional IRA (pre-tax investment, tax-deferred growth, taxable withdrawals)

Contributions into traditional IRAs are tax-deductible in the current year (subject to limits). After that, funds in the account grow tax-deferred. However, traditional IRAs have required minimum distributions starting at age 72, and all withdrawals from the IRA will be taxed at your marginal tax rate in retirement.

Traditional Brokerage Account (after-tax investment, taxable growth)

You make contributions into traditional brokerage accounts with after-tax dollars. Funds in the account do not grow tax-deferred (you will pay taxes on interest, dividends, and capital gains annually).

Small Business Retirement Plans

As a small business owner, a company plan can encourage you to save for the future while cutting your taxes right now!

SEP-IRA (Simplified Employee Pension)

It is NOT a pension plan but rather a defined contribution plan funded solely through employer contributions. Employers must contribute a uniform percentage of pay for each participant but can change the amount each year and are not obligated to contribute.

SIMPLE-IRA (Savings Incentive Match Plans for Employees)

Similar to 401(k)s, this plan is funded through a combination of elective salary deferrals by employees and required employer contributions each year. Employers must either match employee contributions (up to 3%) or contribute a fixed percentage of each participant’s salary.

Diversification

Most people understand that putting all of your eggs into one basket is risky.

Asset Diversification

For diversification to work, your portfolio needs asset classes that rise when others fall. These asset classes are said to have a negative correlation.

While purchasing stock index funds does help diversify your stock portfolio, your goal is to diversify your entire investment portfolio.

Stocks and bonds form the foundation of portfolio diversification since the bond market (on average) negatively correlates to stock market movements.

Other asset classes to consider in retirement planning include real estate, venture funds, annuities, and cash.

Tax Diversification

Will taxes rates go up over your retirement planning horizon? Will you be in a higher tax bracket when your retire than you are today? Or do you expect to be in a lower tax bracket in retirement than your prime earning years?

Because none of us have a crystal ball, tax diversification helps to mitigate the risk inherent in this uncertainty. Therefore, having pre-tax and after-tax investment vehicles in your retirement portfolio is essential.

Sources

Whether this is a problem you are currently facing or just something that has been weighing on your mind, feel free to contact me via phone or email so we can discuss your situation, goals, and solutions.

steve4

I built my first career in management consulting and have spent the last 20+ years putting my passion and skills to use in community and economic development. For the past seven years, I have provided business advice to hundreds of start-ups and small businesses.

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