Why Your Nest Egg Should Extend Beyond Your Business
Say you’ve run your own business for years, pursuing a dream you’ve had since your late teens. You’ve tried to do everything the right way and have a strong client base and loyal employees, as well as a solid earnings record over four decades. You’ve also tried very hard to provide for your family, and you’re proud of the example you’ve set for your kids and grandchildren.
However, with retirement right around the corner, you’re suddenly facing a serious problem, one that even your highly qualified team of financial experts couldn’t have predicted. Because you consistently reinvested your profits in your business, your personal wealth isn’t nearly what it should be.
What do you do now? Keep working another five years? Admit to your spouse that the sightseeing trip to Europe won’t happen anytime soon, and that the youngest two kids — both in graduate school — may have to pay much of their own tuition?
As I interact with business owners across the country, one of the most common things I find is that they are addicted to their own businesses. Because of that, they often take every last extra resource they have and reinvest it in their businesses. This is not a bad thing. It’s part of the spirit of entrepreneurs and the spirit of capitalism.
However, the challenge comes as they try to grow their own personal wealth. They feel comfortable and say things to themselves like, “I have this business. I know what the bank account looks like inside of the business. I know what my potentials are.” They live in a world of pipelines as they consider how much money may come in over the next two or three years. While this may be great from a business and visionary standpoint, it is actually killing their personal wealth. You want the government to treat your business and personal accounts separately — for tax purposes — but many business owners fail to follow the same rules themselves for wealth purposes.
Finances inside a business are incredibly complicated. Most business owners don’t go to school to study bookkeeping. As a result, they are constantly playing catch-up with their team of financial experts and bookkeepers on how the money is moving around. One of the challenges is the concept of retained earnings. Retained earnings are often left in S corporations. In a C corporation, the corporation has paid tax on its earnings, but because the earnings remain in the company, they have yet to be taxed at the personal income level. In an S corporation, the owners pay personal income tax on the earnings because an S corporation is a pass-through entity — in effect, the owners personally own the money and have paid tax on it, but it sits in the business account.
One of the common challenges I hear from my business owner clients is this: “I write big checks when it comes to tax time based on income, but I don’t have the money to show for it.” One of the reasons for this is because the money stayed in the business. Understanding how retained earnings work can be a significant issue. With simple bookkeeping errors, money can roll over from year to year, or the basic practice of keeping the money in the business may cripple the business owner’s ability to grow their wealth.
The taxes can be overwhelming in this scenario, because the majority of small business owners do not have the knowledge of the tax code or a team to navigate the best structures or strategies. One of the common solutions suggested by financial experts and bookkeepers is to use write-offs. But then, the business owner can find themselves in the midst of trying to find things to buy, whether equipment, inventory or pre-funding product to be sold later. Soon, they are expensing and paying for a number of things simply for the purpose of reducing their taxable income at the end of the year. I have known of farmers who buy brand-new combines only to let those sit in the barn with the stickers on, unused, to save taxes. They never needed a new combine; they just followed the advice they were given. Ultimately, this practice jeopardizes how much money entrepreneurs can put in their pockets and how they grow their personal wealth.
I would say 80% of entrepreneurs I run into have not had conversations with teams of financial experts along the lines of tax liability and how to effectively and legally reduce it. Something as simple as being a regarded entity and having the proper economic substance is never brought up. Thus, owners of small to midsize businesses often don’t know about the tax strategies available to them.
If you got into business to do what you love and to grow your wealth, I encourage you to seriously look at how it’s working for you. Measure your personal wealth outside the business, and determine if the net effect of your current strategy is growing your nest egg or someone else’s. Know that there are options and strategies to help. For many business owners, the nest egg is the business, but not only is that not enough; it is usually significantly compromised by taxes, poor planning, liabilities and lack of focus.
So to build your own nest egg and secure your future, consider including in your team of professionals those who can advise on tax planning, asset protection and retirement strategies that are tax-free. Otherwise, retirement may be much farther away than you think.
“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”
— William Arthur Ward, writer