This is a guest post by Leonard Raskin, a Registered Representative and Financial Advisor of Park Avenue Securities, LLC (PAS). He is the principal of Raskin Global, a wealth management and financial advisory company based in Hunt Valley, Maryland.
If you’re several decades away from retirement and you’ve recently started an IT business, putting money away for retirement may not be the smartest thing to do on day one. Controversial, right? A financial advisor saying you might not want to put money in your retirement fund.
Don’t get me wrong: setting money aside for retirement is absolutely essential. It’s not something you can skip. But like anything else, retirement planning requires some strategizing, especially for entrepreneurs.
In this article, I’ll explain why it’s sometimes smarter to hold off on retirement investing and what to consider when you start putting money aside.
Saving for Retirement? Make Sure You’re Liquid
Let’s say you start an IT consultancy and from day one, you set aside 10 percent of your funds for retirement. A year in, you’ve got more work than you can handle and you realize you need to take the plunge and hire a full-time employee. Congrats.
This also means, however, that you’ll have to rent office space and buy computer equipment for the new hire. Unfortunately, you don’t have a ton of liquid funds to make all those upfront purchases. If you tap into your retirement account to cover the costs, you’ll face a 10 percent penalty plus any taxes you didn’t yet pay. And that’s all to access your own money.
The point here is that some things are more valuable to early-stage businesses than retirement funds. In the example above, the new employee could have helped your business grow revenue substantially, allowing you to put away enough money to make up ground you might have lost by not investing right away. If you don’t have the funds for those costs, you’ll have to pay to borrow one way or another.
The tricky thing, of course, is understanding retirement vehicles well enough to determine which one to use when it’s time to start investing.
A Crash Course on Retirement Products for Small-Business Owners
Once you’ve determined that your business is sufficiently liquid enough to start investing in retirement, you have to decide which type of retirement account makes the most sense. I highly recommend working with a financial advisor on this one because everyone’s individual circumstances are different and there are lots of complexities I’m not going to get into here.
Use the following as an introduction to thinking about various ways to put money aside for your future if you’re currently the only person in your business.
- IRA: Money goes in tax-free and grows tax-free, but you pay income tax when you take money out (plus penalties if you do that before you’re 59 and a half). Generally speaking, this is a good choice if you think you’ll be in a lower tax bracket during retirement than you are now (i.e., you’ll be earning less from your retirement funds than you do from your business, so the future taxes you’d pay would be less than the taxes you’d pay today).
- SIMPLE IRA: This is an IRA designed specifically for business owners. It functions like an IRA but you can put more money in per year (up to $12,000 annually, as of 2014). There are significant restrictions if you want to take money out early, including a whopping 25% penalty for withdrawals in the first 2 years. Translation: be liquid before you start this fund.
- SEP IRA: Again, this plan allows for pre-tax contributions that are taxed when you take them out. The difference is that you can put more money into an SEP IRA – up to 25 percent of your income, or $52,000 per year.
- Roth IRA: This fund lets you save after-tax dollars that grow tax-free and can be used tax free. Generally, a Roth IRA works well for people who expect to earn more money per year in retirement than they do now. The downside is that there are limits on how much you can put in and if you earn more than a certain amount, you aren’t eligible. In fact, the irony of the Roth IRA is that those who could benefit the most from its structure usually can’t afford to fund it much.
- 401(k): This retirement tool lets you put away significant pre-tax money (right now, up to the lesser of 100% of your income or $52,000 or $57,500 per year if you are over 50), but it’s more complex than the other vehicles. In addition to more government oversight for 401(k)s, these plans come with additional costs, including the cost of setup, annual reporting, and administration.
If you have employees, the picture becomes more complex. While you can still choose any of the above plans, you have to contribute to your employees’ funds generally whatever you contribute for your own. I won’t get into those details here because if you’re at the point of creating retirement accounts for employees, you are hopefully already working with a financial advisor who can help you set things up.
Retirement Savings: A Cautionary Tale
One final note about saving for retirement: even if your business is off the ground or you’re getting close to retirement age, it is possible to put too much money aside in retirement plans, simply because of the way retirement funds are restricted. Say, for example, you’re moving across state lines for a new job at age 48. You’ve got lots of money in your retirement fund, but of course you can’t touch it without penalties.
You’re excited for the move, but your current home isn’t selling. You know it will sell eventually (it’s a great home), but you need cash for your down payment on the new home because the new job starts next month. If you had less money in a retirement fund and more cash on hand, the problem wouldn’t exist and you’d be free to enjoy your new life without worrying. (I’ve seen this scenario play out in real life – it’s frustrating, especially when the money’s there but not freely available.)
The moral of the story? Recognize that retirement planning is complex. Start thinking about it right away, but recognize that sometimes it makes sense to wait.
For more information about financial planning and wealth management, check out the newsletter archive on the Raskin Global website.
Leonard P. Raskin is a Registered Representative and Financial Advisor of Park Avenue Securities, LLC (PAS),954 Ridgebrook Road, Suite 300, Sparks, Maryland 21152. Securities products/services and advisory services are offered through PAS, a registered broker-dealer and investment advisor. Field Representative, The Guardian Life Insurance Company of America (Guardian), New York, New York. PAS is an indirect, wholly-owned subsidiary of Guardian. Raskin Global is not an affiliate or subsidiary of PAS or Guardian.
PAS is a member FINRA, SIPC.