Looking for New Ways to Save Money?
Consider a Salary Continuation Plan
Congratulations, you did it. After years of hard work you've finally built your plumbing business into something you can be proud of. You started with nothing, borrowed what you could, and despite all the obstacles, you built a business that stands out in an age of mediocrity and risk avoidance. So now what?
As meaningful as it is to you, all the equity you've built up hardly guarantees a secure retirement. This is true because you'll have to sell your business in order to cash out. And before you see a dime you'll have to cash the IRS out. You'll also have to pay off your creditors, your attorney, and the broker who helped sell the business. If you're able to keep 60 cents on the dollar, you're lucky. And all this assumes you're able to find a buyer who's willing to pay a fair price.
What if your son or daughter wants to run the business, to carry on after you retire? Do you sell to him or her? How? If your plumbing company is worth $1 million and your children agree to pay you $75,000 per year, this barely covers the interest the IRS says they have to pay. Also, your children will have to buy the business with after-tax dollars. They'll have to earn $115,000, pay the IRS $40,000 just to pay you $75,000. At this rate it'll take them 30 years to pay you off-by that time they'll be ready to retire themselves. So how do you get your equity out of the business?
There are lots of ways, but one of the best is to adopt a salary continuation agreement plan as part of the sale. You fund the plan for a few years, and it will pay you for as long as you want. The payments will be taxable to you, but deductible to your heirs. This will make it easier for them to make the payments to you. When you die, your son or daughter in the business will get the company and your other children who are not active in the business can receive other assets. All your children will be treated fairly.
Reverse DiscriminationDuring the last couple of decades, there has been a none-too-subtle shift in the law that has created a climate of reverse discrimination against the owners and key employees of small businesses. And nowhere is this more evident than the construction industry. Social security, workers compensation, unemployment insurance and medical insurance all reward people in reverse order of their productivity and salary, to say nothing of their loyalty. Even retirement plans cap how much money the "highly compensated" can put in, and it's always less than it needs to be.
You may have owned your company for 10 years before you could afford to put in a retirement plan, and your key employees may have been with you right from the beginning. Once you adopt a plan, everyone must participate after just three years of work. Is that fair? How are you going to compensate yourself and your key employees for all the years you worked without a plan?
You could give yourself a big raise, but that just ends up costing you more in taxes. We call that the paycheck squeeze, and it's not a very efficient way to build wealth. It's also hard to know that the business will continue to be able to pay that higher salary. Recessions do happen after all. So what can you do to make up for the short-sightedness of our elected leaders? Again, a salary continuation plan could work wonders for you.
With this type of plan, you can include just yourself or any number of key people. The important point to remember is that you can exclude anyone you need to. You can defer money you earn in a good year to your retirement years. There is no income tax on the earnings, and oftentimes the plan can be set up in such a way as to allow for tax-free distributions. There is virtually no government reporting, and no annual compliance testing.
Golden HandcuffsAs I mentioned earlier, you get to decide which, if any, of your employees get to benefit from the plan. You can use it to recruit and retain key employees, and you can set it up as part of an incentive plan to keep your people focused on the bottom line. Best of all, you can create a long vesting schedule.
You can, for example, give an employee 50% of his salary for 15 years after retirement. This is similar to an old-fashioned defined benefit plan. On the other hand you could deposit a set amount, say 7% of his pay, into a plan until he retires, and he can have whatever it grows to. This is similar to a defined contribution plan. In either case, you could have a vesting schedule of 10 or even 20 years or more. If the employee leaves before that time, he forfeits everything.
Who's going to hire him away? How much of a signing bonus would it take to make up what they'd be leaving behind. You can have an employee focused on the bottom line without having to make him an owner. The money you set aside for the employee is not taxable to the employee, and it remains an asset of the company. If you need the money for a short-term cash crunch, it's available for company use. However, you probably wouldn't want to make a habit of spending money you're trying to set aside for retirement. This would defeat the whole purpose of the plan.
Whether you're getting ready to retire, or if you are just beginning to save for retirement, a salary continuation plan deserves a close look. It is a valuable tool.