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Change is an inevitable aspect of every life cycle. With business, the final evolution can take a variety of forms. You may be ready to retire and pass the business on to a family member. Perhaps your goal is to sell to outside investors and use the proceeds as a retirement nest egg. Or the business may have declined so much that the best exit is a legal dissolution of your company. These tools and resources will help you manage the big decisions ahead for a successful transition.
For an exit plan to be successful, one of the first things you need to do is to complete an assessment of the owner’s financial needs in retirement. In preparing an exit strategy, the goal of this calculation is to determine the amount of money the owner will need to get from the business upon exit.
Most entrepreneurs take enough money out of their business to live comfortably. Unfortunately, they do not build any significant investments to fund their retirement. Then when it does come time to retire, the only thing they have to rely upon is their equity in the business. Most entrepreneurs believe the best return on their investment is in their company where they have control of decisions and know the industry. In addition, the tax code requires that contributions to retirement plans be non-discriminatory. That means all employees have to be treated in a manner similar to the owner. Because of the additional cost of this requirement, many business owners do not take advantage of the tax benefit of retirement plans.
Since the primary asset of most entrepreneurs is their company, they want to maximize the sales price of the company when it is time to retire. They look at this sales price as their reward for years of hard work and also personal self-esteem. The higher the sales price, the greater their sense of accomplishment.
In order to determine what the owner will need to get out of the business when it is time to retire, the first step is to estimate his or her retirement living expenses.
To determine how much money, you will need to fund your retirement, there are five questions that must be answered.
Once you have agreed upon the answers to these five questions, please use either of our retirement calculators, also in this section, to assist you in determining the amount of money you will need to accumulate for your retirement.
No two individuals are the same and this is true of retirement live styles also. While the expense of some people will decrease in retirement, others will increase as they spend more money on recreation to occupy their time. These differences have a profound effect upon your retirement planning.
For years, financial planners have used a rule of thumb that the average person needs 70% of their income prior to retirement. This rule of thumb makes the assumption that your expenses will decrease because your children are probable adults now and supporting themselves, you are no longer saving for your retirement, and your mortgage on your home has probably been paid off.
Today, many financial planners have increased this rule of thumb to 80% because of increasing medical costs in retirement. Estimating medical costs and long-term care expense are difficult to do. The inflation rates for these expenses have been higher than the CPI index and are often under estimated in most retirement plans.
While the rule of thumb method will give you a good starting point, that is all it is. In addition, if you are young and have several years before you retire, this approach will be sufficient for your retirement planning. However, as your retirement date gets closer it would be wise to take a detailed look at your projected expenses in retirement. This will give you an opportunity to adjust your retirement savings plan or change your lifestyle expectations during retirement.
To project you living expenses in retirement, a detailed analysis of the owner’s expectation in retirement should be considered in the calculations. One person may be perfectly happy living in their current home, is not interested in travelling and has inexpensive hobbies. Another may be planning to move to Florida or Arizona, purchasing a new home, and playing golf three times per week. While a third individual may plan to travel extensively in retirement. Each will have a very different cost of living in retirement and the only way to properly plan for the owner’s exit is to take these desires into account in the calculations. It is very possible that some will spend more money in retirement than when they were working.
When listing your expenses, do not forget to include an allowance for medical expenses, income taxes, transportation expenses and housing expenses. If you retire at 67, you will probably trade vehicles at least two or three times during your retirement, and you will need to pay for the insurance, license, fuel and maintenance on the vehicle. While you may have your home mortgage paid off, during your retirement you will still have real estate taxes and insurance to pay on your home. In addition, you will probably have to replace the roof and the heating/air condition system once during your retirement.
It is difficult for most people to identify all of their living expenses. If you try to list all of your current living expenses, most will invariable miss some. The easiest way is to start with your current income and back out money you are saving toward retirement and other expenses you currently have that you will not have in retirement. Examples of expenses you may now have but will not have in retirement would include professional wardrobe costs, commuting expenses and professional dues.
Once you have determined what your current living expenses are, you must add expenses that will increase during retirement. An example of this is the cost of medical, dental and vision insurance that will no longer be paid by the company.
This approach takes into account the individual’s discretionary living expenses. As an example, one person may eat all of their meals at home while another goes out to a gourmet restaurant twice per week. These variables will be accounted for in this approach.
Once you have projected your annual living expenses, the next step is to look at what your retirement income will look like. To project your other retirement income, you can take the following steps:
Once you have projected your other retirement income, subtract it from your projected living expenses to get your retirement income gap. This is the amount of income you will need to get from the sale of your business.
We have attached a worksheet to assist you in calculating your retirement funding gap.
Once you have determined what you need to get out of your business to fund your retirement. We have provided a calculator to assist you in this process. We highly recommend that you use this calculator because it takes into account the compounding effect of inflation on your retirement. If you retire at age 67, your retirement plan should cover a minimum of 20 years. Most retirement planners would recommend a 25-year life expectancy for your retirement plan.
If these projections show that you have not saved enough for your retirement and the sale of your business will not cover your funding gap, you have three courses of action to correct the situation:
While these are steps you may not want to take, they can have a huge impact upon your retirement finances.
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