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Are You Putting Too Much Money Back Into Your Business

When you started your company, no doubt investment capital was at a premium. Many entrepreneurs borrow from family and friends, tap home equity, and run up credit card balances to the limit. Though risky, that’s just the cost of following a dream. But now, with your business humming along, you may face a different risk. Failing to take money out of the company could imperil your long-term personal financial health.

One problem with paying yourself too little and not funding retirement savings is familiar to anyone who remembers the corporate meltdowns early this decade. When erstwhile Wall Street darlings suddenly crashed and burned, employees were left holding virtually worthless company shares. A similar fate could await owners of small businesses who keep most of their net worth tied up in company stock. If you’ve poured all of the profits back into the business, what will you be left with if it ultimately fails?

And even if it keeps growing, at some point you need to ask yourself exactly what you hope to accomplish. Are you planning to take the business public someday, generating a big, long-deferred payday for you and the company’s other investors? Do you hope to hand off the business to another member of your family? Or are you simply plowing money back into the business for growth for its own sake?

In some scenarios, it may make sense to reinvest as much capital as you can. But the road to an initial public offering is long and treacherous, and very few small businesses ever get there. And what if the heir you’re counting on to take the reins ends up having other plans? Though there are plenty of other ways to exit a business, including a sale to a competitor or to your own workers through an employee stock ownership plan, those options, too, put off your ultimate payday and assume the company will continue to thrive.

Instead, you could approach your role with the business as if you were leading a major corporation. Though corporate executives may defer some compensation, they also make sure to receive generous salary packages and fully funded retirement plans. They realize that while they may be on top now, that could change overnight. They also want to be able to live well, enjoying the perks of success while still young and healthy.

How much should you take out of your business? And what are your options? You might start with your own compensation. “Pay yourself first” is timeworn advice, but it’s also essential, and in developing the annual budget for your company, begin by penciling in competitive compensation for yourself. Once you acknowledge that as a necessary cost of doing business, it will become less of an issue as you chart plans for future growth. And the money you take home will be a tangible reminder of what you’ve been working so hard to achieve.

For retirement savings, there are many possibilities. If you have done little so far or simply want to pull out maximum cash from your business, a defined-benefit plan could help. Here, you work backward from a specified future benefit to determine how much your annual contribution must be. In most cases, this requires actuarial calculations taking into account years to retirement, life expectancy, and other factors, and you’ll need to fund future benefits for a number of your employees as well. Businesses with only a few workers can consider off-the-shelf defined-benefit plans, while plans built around annuities or life insurance might enable you to set aside several hundred thousand dollars a year. And all of the company’s contributions are tax-deductible as a business expense.

A wide range of defined-contributions plans, from garden-variety 401(k)s to SIMPLE and SEP IRAs and profit-sharing plans, could also help you pull out money from your business while reducing taxes and providing retirement income. One major advantage of such plans is that, unlike defined-benefit plans for which annual outlays are mandatory, you may be able to contribute less in years when business is slow. And while annual contribution limits are lower for defined-contribution plans, your business could use both kinds of plan to maximize tax-advantaged savings. Moreover, 401(k)s and most other defined-contribution plans offer relatively broad investment options that can help diversify your retirement savings.

We can work with you to sort through the many options for funding your current and future compensation and will gladly answer whatever questions you may have on these topics.


This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.




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