Retirement Planning Basics For Entrepreneurs

I’ve had some conversations with Entrepreneurs over the past couple of weeks where I needed to dispel some popular beliefs about retirement. The following are some of the facts that all should take into account, when planning a long and happy retirement.

Social Security Is Taxable

Originally, when President Roosevelt pushed through the FICA or Social Security Package, he promised that it would never be taxed. Under the Clinton Administration, with then Vice President Gore casting the deciding vote in the Senate, up to 85% of your Social Security Benefits are now taxable at regular income tax rates.

Tax Advantaged Retirement Plans Are Also Taxed

401K’s and other Qualified Plans give you a break today, so that you can pay taxes tomorrow. The IRS is happy to do this. Why?

If you put away let’s say $50K and don’t pay income tax on it, hopefully it will grow. By the time you retire, let’s say that it becomes $150K. You will then pay regular income taxes on $150K at that point instead of $50K.

The Service is happy to give you a break today so that they can collect three times the tax when you retire. When you consider the payroll taxes that must also be paid in order to fund these Qualified Plans, you begin to realize how expensive they actually are.

So much for the concept of a “Tax Advantaged Plan”. If you’re an employee, they’re the best thing since sliced bread, but as an Entrepreneur it’s different. Why? Because you have to pay all of the taxes involved.

Successful Entrepreneurs don’t rely on only Social Security and Tax Advantaged Retirement Plans to retire comfortably. It’s generally not even close to enough. Let’s set up an example.

We have a married couple who live comfortably on $200K annually. When they retire, their social security benefits will be $40K per year.

They need to make up another $160K annually. We normally figure retirement savings to grow at an average rate of 5%, which means that they’ll need to save an additional $3.2M. Given the $20K that most people put away annually into 401K’s and the like, they’ll never get there in the time they have before retirement.

My point is that in most situations social security and retirement plans are simply not enough. Most successful retirees have substantial savings sitting in regular stock accounts not tied to any formal retirement plan.

Let me leave you with this.

I didn’t write this column to beat up on the Social Security System. Doing so would be much too easy. My point is that to successfully retire, there are four things to consider.

1 – Social Security Benefits
2 – Formal Retirement Plan Benefits
3 – Additional Savings
4 – The Ability To Retire Completely Debt Free

I have long been an advocate for reducing entrepreneurial salaries to a reasonable point, and increasing distributions to save payroll taxes. In doing so, an entrepreneur can invest the savings. At the end of the day, our own money is the only thing that we can really rely on.

Let’s set up another scenario. An Entrepreneur operates an S Corp and normally takes out a $200K salary.

The owner of a profitable S Corp must take out a reasonable salary, so let’s say that we can find other instances where a $50K salary is reasonable. In addition to the salary, he takes out a $150K distribution to make up the difference.

Doing this doesn’t save a dime in income tax, but it will save $16,378 in payroll taxes annually. If he invests those savings, along with his other benefits, he’ll probably do better in the long run.

There’s another potential plus depending on his income tax rate. If he invests those savings into a regular account rather than a “Tax Advantaged” account he’ll pay capital gains tax instead of regular income tax.

Depending on his tax rate those capital gains taxes might be lower and he might come out better in the long run. Again, the rules are different for us.

If you don’t have anyone doing tax planning for you or your family, you might want to give us a call.

Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Employee Retention Credits, M&A Due Diligence, Payroll Services, or Accounting and Tax Work, you have but to ask. I’m here and I remain,

Sincerely yours,

Chris Amundson
President
Accounting Solutions Ltd.
773-267-7500
888-310-0300

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