Accessing Your Retirement Income: Sooner Or Later

FROM FORBES.COM-

Most business owners want to retire … eventually; some sooner than others. While some owners profess to never wanting to exit their businesses, we know that ultimately everyone must exit. A business owner who sold his business at age 54 never looked back. He’s living the good life, playing his guitar and enjoying his grandkids. In contrast, last month a business owner told me he has retired three times. He just keeps, “getting sucked back into the business world.” Even so, I know countless business owners who are doing well physically, mentally and financially; and are looking for ways to put off retirement. No matter where you stand in this continuum of desires, it’s wise to have a plan for how you can get at your retirement funds when you need them.     

Getting At Your Income SOONER

Successful business owners are more able to retire early than most employees. They have equity in their businesses, substantial control over their compensation and tax structures, and there is no upside limit to their earning ability. Early retirement — or at least a planned slowdown —is a payback for long hours worked and risks taken. There are a number of ways business owners can access retirement capital without having to necessarily sell their business. Consider these three popular approaches.    

1. Qualified Money:  As a business owner you may have built up a sizeable qualified retirement plan, but are frustrated by the fact that you can’t get at those funds. Taxable withdrawals from qualified plans before a participant attains age 59 ½ are subject to an early 10% withdrawal penalty. There is, however, an exception if taxable withdrawals are taken in the form of “substantially equal periodic payments.” Commonly referred to as a “72(t) plan” or a “SEPP.” A 10% penalty tax will not apply to these pre-59 distributions as long as you follow the rules. The amounts must be distributed at least annually, be calculated as a life expectancy payout and continue for a minimum of 5 years or until age 59 ½ (whichever is later). There are three methods for designing these payouts, each with their own advantages and disadvantages. All, however, have the benefit of allowing you to start drawing down your qualified plan money early. 
2. Life Insurance: Qualified plans are a great way to defer taxes on current income, but there are limits on how much you can put in a plan and distributions are generally taxed as ordinary income. There is a product you can add to your portfolio in which you pay your taxes now, are not limited in how much you put away, and can receive tax-free income in the future — cash value life insurance. Excess capital that has already been taxed can be used to fund a cash rich life insurance policy. The cash values will grow tax-deferred. Then, when you are ready to start taking an income, you can first withdraw your principal tax-free and then switch to loans against the policy’s death benefit. The remaining death benefit provides a source of income if you have a spouse or children to support in retirement. Since life insurance is subject to insurability, this is a tactic a business owner should address well before the need for retirement income is pressing.     
3. Recapitalization:  There are ways of leveraging your business equity that fall short of actually selling your entire business. With an improved economy, recapitalizations (recaps) are back in vogue, even for smaller companies. Essentially with a recap you are exchanging your business equity for a combination of cash and a piece of the capital stock of a new entity intended to support the company’s future growth. The concept can be analogized to taking some of the chips off the table, but letting you stay in the game. There are many uses for recaps, but one is to monetize some of the owner’s equity. It’s a way to “liquify” your business without liquidating the operation. Plenty of investment banks, private equity firms and other financers are structured for privately-held businesses. 

Delaying Your Income Until LATER

I had helped my father set up an IRA many years ago. Eventually he retired and, when he came into his 70s, found out he had to start taking required minimum distributions (RMDs). He was furious about being forced to take taxable distributions when he didn’t need the money. Back then, there weren’t many ways to avoid RMDs. Nowadays, there are a number of ways to structure a portfolio to delay the receipt of taxable income. Consider these three ideas. 

1. Backdoor Roth: The Roth IRA concept has proved disappointing to many business owners because of the income limits placed on who can contribute ($191,000 income for a married couple) and how much you can contribute ($5,500 per year). Still, there is an approach that can help business owners who, like my father, want to put off receiving RMDs: A so-called “backdoor Roth” allows high income earners to delay receiving retirement income. With a backdoor Roth, the high income earner contributes to a traditional IRA and then converts that IRA to a Roth IRA. It accomplishes the same thing as opening a Roth directly, but avoids the limits on contributions.  The conversion will be taxed, but the account then grows tax-deferred and will pay out tax-free.  Think of it as paying tax on the seed and not on the harvest. Best of all, Roths are not subject to RMD rules, thereby allowing you to push off taking an income into the future. 
2. Deferred Income Annuities:  I recently discussed the trend towards using deferred income annuities (DIAs) as a safety net for retirement income. These contracts involve putting money away currently into a contract that will, later in life (say age 75 or 80), pay out an income you can’t outlive. For the business owner who wants to delay retirement and stay in the business, the DIA can be an effective way to lock in an income stream for the golden years. And, now you can use your qualified plan funds as the source of that income stream. On July 1 the Treasury issued final regulations amending RMD rules to allow annuity investors to start collecting later. If you want to delay receipt of qualified money, you can put some of the funds in a DIA, and thereby avoid being forced to receive taxable income in the form of RMDs. 
3. Your Business:  Finally, don’t forget that your business ownership offers tremendous flexibility in retirement income planning. You can structure cash flows and tax events so as to exit on your own terms. There are too many tactics to address here, but let me offer an example. Accumulate that income in your business as a way to delay receiving a retirement income. If you are an S Corp or LLC, your business income will be taxed to you as it is earned, but that also means you’re building an account of after-tax income. When you want to start slowing down at work, you can reduce your taxable salary, and instead start taking out tax-free dividends.   

Business equity is a wonderful thing to have, but some day you may also want retirement income.  You don’t have to decide now when you’ll receive retirement income, but it makes sense to have a plan for how to receive that income so it’s there when you need it.