Save for Retirement When at Your Peak
Start deferring compensation now. Rule One of estate planning is: Never depend on your successors.
An urgent message to business leaders in their 40s and early 50s: Pay the price of succession during your peak years. Make plans now to finance your retirement outside your company. Don’t plan to keep on tapping company cash flow after your successor is in place.
Recently, I participated in a panel discussion on business compensation in which we were asked to discuss a hypothetical case. The entrepreneur in the case had “retired” in his early 50s after turning the business over to his children, who were in their 20s. They were struggling to keep the business going.
At first we panelists complained that the case was unrealistic, that the succession issue wouldn’t happen in the real world until the family members were at least 10 years older—the founder in his 60s, his children in their 30s or 40s. Our hypothetical founder’s retirement was premature. He would be back to “rescue” his children from their inexperience. Real succession would then occur much later.
But as we worked through the case, we realized that the real issue was not so much making succession work as paying the financial price of eventual succession. Many business owners I know balk at securing their retirement income in their 40s or 50s. They are preoccupied with building the business and becoming “wealthy,” according to their (often grandiose) expectations.
My favorite definition of “wealthy” is: the financial ability to maintain a relatively high lifestyle—indefinitely, without working, and with little risk.
Most of my neighbors who are retired corporate executives fit my definition of wealthy. As they age, their net worth becomes less important than reliable retirement incomes. Their financial security is less vertical (balance sheet) and more horizontal (cash flow statement).
But aging business leaders who must depend upon the uncertain future profitability of the family company to finance retirement are not wealthy, regardless of net worth. It’s the risk that disqualifies them. That risk arises out of their declining physical and mental ability to run the business, combined with the unproven acumen of their successors.
It may be difficult for a gifted entrepreneur, at the peak of his or her success, to take money out of a business that is growing at the rate of 20 percent to 30 percent per year, and invest it in retirement assets that—according to the numbers—may be much less attractive. In their 40s and early 50s, most entrepreneurs can’t yet think realistically about retirement, and may not listen well to appeals to put significant wealth outside the company in less risky investments. To him or her, this may not make economic sense.
But given the price of future family succession, a very important case can be made for deferred compensation. Unless the business leader provides for retirement outside the family company, he or she is violating Rule One of estate planning: Never make the parents dependent upon the children.
Like it or not, the aging business leader is becoming increasingly dependent on grown children to finance retirement. Of course, there are alternatives:
•Sell the business to third parties and finance retirement out of after-tax proceeds.
•Sell the business to the children, if they can find and live with outside financing.
•Sell to the children directly on the installment basis, but remain dependent on them to run the business well enough to make the payments. Rule One would be violated until the children repaid the purchase price.
But why engage in retirement planning that would require sale of the business? When the time for succession comes, selling may make good sense or it may be a terrible idea. It makes much more sense to provide now for retirement outside the company, without regard to the unpredictable needs of the business when the time comes to retire. Why risk having to hang on because you can’t afford to let go?
The advisers on that business compensation panel passed along a wake-up call. The time to lock in deferred compensation for leaders of family owned businesses is long before the family begins to focus on management succession. There are a number of vehicles, including:
•Maximum contributions to a 401(k) or other qualified retirement plan.
•Investment of after-tax income in the securities markets, real estate, or other promising ventures unrelated to the family business.
•A non-qualified plan funded with company-owned and purchased life insurance that can be tapped to pay retirement income benefits and eventually reimburse the company from the death benefits. Under current law, premiums aren’t deductible to the company, but the payout of retirement income is a deductible expense. And the cash value of the policy builds up tax-deferred.
Don’t violate Rule One of estate planning. Pay the price of succession during your peak years.
Gerald Le Van is managing director of the Le Van Co., with offices in Charlotte, NC, Houston, and Phoenix, and author of The Survival Guide for Business Families (Routledge, New York, 1998).