Financial Strategies For Small Business Owners
This episode covers small business owners’ long term financial interests and applying wisdom to the decisions they make today for a bright future.
Small business owners are extremely busy, and they are constantly being pulled in many different directions. Many questions small business owners face include:
- What is my cash flow going to look like in the future?
- Is there enough new business coming in?
- How could I control expenses better without sacrificing quality ?
- Will I have enough after paying everyone else, taxes, and all the business expenses for my own family?
- Will I have enough to retire on in my later years?
As financial advisors that serve other small businesses every day, Bob and Mary Jo understand the small business owner and want to help. They decided to address some of the issues that small business owners need to be thinking about and taking action on.
Saving for your financial future is one of the most important things you need to do, but can be hard to find the money to save after all of the self employment taxes, income taxes, and business expenses. If you are a small business owner or you know one, you will want to listen in as they discuss the many issues that affect them.
HOSTED BY: Bob Barber, CWS®, CKA® and Mary Jo Lyons, CFP®, CKA®
Mentioned In This Episode
CIS Wealth Management Group
Bob Barber, CWS®, CKA®
Mary Jo Lyons, CFP®, CKA®
Bob: Welcome to Christian Financial Perspectives, a weekly podcast where we talk about ways to integrate your faith with your finances. This is Bob Barber.
Mary Jo: And I’m Mary Jo Lyons.
Bob: Are you ready to learn how to apply biblical wisdom to everyday financial decisions?
Mary Jo: Join us as we look at integrating your faith with your finances. If it’s your first time listening, welcome to our podcast, and if you’re a returning listener, welcome back.
Mary Jo: From scripture in the II Chronicles 9:21-24, “The King had a fleet of trading ships, manned by Hiram servants. Once every three years, it returned carrying gold, silver, and ivory and apes and baboons. King Solomon was greater in riches and wisdom than all the other Kings on the earth. All the Kings of the earth sought audience with Solomon to hear the wisdom God had put in his heart. Year after year, everyone who came brought a gift, articles of silver and gold and robes, weapons and spices, and horses and mules.
Bob: Boy, this deals with business, commerce, and wisdom. I just love this scripture as it speaks about applying that wisdom and business. It proves there was commerce back in the biblical times which still applies today. So on today’s podcast, we’re going to be talking about small business owners and their longterm financial interests and applying wisdom to the decisions they make today for a bright future when they’re older and they can’t work as much. So if you’re a small business owner or you know a few yourself and you’re not one, but you know some, like I said, you’ll want to listen in as we discuss the many issues that affect them. I’ll tell you, small business owners, they have a lot to be concerned about and I, as a small business owner, can definitely relate to them as I’ve been a small business owner myself for over 34 years.
Mary Jo: You know, I know what you mean Bob. You know, back in the day my husband and I owned a car detail business. Thus, his obsession with clean cars and clean boats that we joke about a lot on the podcast. The poor guy – actually it’s his poor spouse that suffers – but that’s a whole different podcast.
Bob: His friends suffer too, because when I came down to see y’all the other day, I’m washing my car the night before cause I knew I was coming down.
Mary Jo: Oh his friend say that all the time. Oh he’s a tough critic. And as an independent contractor, I’m also a small business owner, so we can relate to this. And on Google, you know there are a ton of articles on the challenges of being a small business owner. This isn’t anything new. If you own your own business, you’re well aware of the challenges that you face.
Bob: Yes, there’s always these questions swimming around in your head when you’re a small business owner, like what’s my cash flow going to be like in the future? Am I going to be able to pay all my employees? Will I be able to pay all the bills for the business? Is there enough new business coming in? How could I control expenses better without sacrificing quality? How can I attract more customers? Can I provide the health coverage I need for my family and my employees as well. Will I have enough after paying everyone else and all those taxes and business expenses for my own family to live on? What will my income taxes be in the future? You know, these are just many of the issues that keep us business owners up at night. And small business owners, they’re always so extremely busy and they seem to be like a hamster on a wheel much of the time and just can’t get off of it to rest. They’re constantly being pulled in many different directions and wear themselves out with extremely long hours. Many times starting at 6:00 AM in the morning and not stopping until 10 or 11 at night, putting in 15 hour days, many days of the week. Believe me when I say I can relate to this.
Mary Jo: As financial advisors that serve small business owners every day, we understand the small business owners and we want to help. We know that saving for your financial future is one of the most important things you need to do, but it’s hard to find the money to save after all the self employment taxes, the income taxes, and business expenses to put away for your own future. It’s hard. We get that. We thought about how we could help you make this happen. So we came up with the idea of making today’s podcast to address some of the issues that small business owners need to be thinking about and take action on.
Bob: You know, I’m in the process of finishing building a new home and I’ve been asking all of my subcontractors that are small business owners about their retirement plans and it’s interesting. Of all the ones I’ve asked, not a single one so far, and I’m nearly at the end of the home, has a retirement plan.
Mary Jo: Scary.
Bob: And their ability to continue working at their chosen craft is all that is providing for their financial future and that of their family. You know, we can’t solve all of these problems on today’s podcast, but we can look at a few solutions to prepare for the future for a small business owner and minimize these risks.
Mary Jo: You know, Bob, the business owners that we’ve seen that are successful, they work very closely with their CPA and maybe even a bookkeeper on a consultative and a consistent basis. The CPA provides guidance on what is the best retirement plan for them, the one that will meet their goals and objectives for their business. There’s a lot of choices there, but before a small business owner can contribute to a retirement plan, they have to start saving. We have found that this is one of the hardest things for most small business owners to do. They meet with their CPA and always find out that they owe more in income taxes and they thought at the end of the year. So they have to come up with that. And then their CPA advises them to contribute to a retirement plan so they can save on taxes, but they have no savings on hand to make the contributions with. So, it’s just this cycle that perpetuates. So first things first, you need to think about saving more and spending less if you want to protect your financial future. I’ve heard it said that you need to plan to live to be a hundred or die tomorrow. Both take planning, especially from a financial standpoint.
Bob: Yeah, Mary Jo and you know this may mean not buying that new $70,000 truck every two years I’ve been seeing all my subcontractors have. I have just been seeing this a lot and living by a reasonable budget. It seems there’s that pressure to look more financially successful than you really are so everyone will think he or she must be good at what they’re doing because they sure look like it by how they live. Little do they know that so many of these small business owners have everything financed to the hilt.
Mary Jo: You know, and I think that kind of comes back to that whole thing about being content with what you have, and we’ve talked about that so many times on our podcast. So how do you create a retirement savings strategy when you’re the employer? What happens when you don’t have a corporate sponsored employee benefit plan to rely on? Maybe one that offers a 401k or other similar retirement plans like most employers do? It’s still important to put something away for retirement. You have to do it yourself. As we talked about, a good CPA will look at your situation. Look at how much you have available to contribute, how many employees you have, what your goals are. For example, do you want to have a plan that you as the employer are the only one that makes contributions to, or do you want a plan that allows your employees to contribute also? After all, they should have some skin in the game like you do, don’t you think?
Bob: I think they should. And you may just want to start in a retirement plan in the beginning only for yourself. But a lot of small business owners and their employees, they become like family over the years, so they want to offer a plan for them as well.
Mary Jo: You know, Bob, think about this, small business owners are the number one employer in the country. So think about how many people that impacts, and if they’re not offering retirement plans to their employees, that’s a lot of people that aren’t gonna have anything else saved for retirement that are just going to have to live on social security, and that’s almost at the poverty level.
Bob: Yes, you’re right. So the first thing is is start on that retirement plan and then offering it to your employees and helping them. So once you’ve decided this is gonna become a priority to save for your future, you need to get with your CPA, like we’ve been saying, or hire one if you don’t have one, and determine what’s the best retirement plan for you and your business. So what we are going to do today is we’re going to go over five different kinds of retirement plans specifically geared for the small business owner that we’re going to talk about each one.
Mary Jo: First, there’s the individual IRA. This is a good plan for those just starting out and can’t save more than $6,000 a year individually or $12,000 a year if your spouse works in the business with you. These are individual plans and have no employee element. If you have employees, they can set up and contribute to their own IRAs. If you can save more than this, one of the following four retirement plan options just might be a better solution for you.
Bob: So the second type of retirement plan that we’re going to talk about for a small business owner is a SEP IRA plan, which stands for Simplified Employee Pension. And this was a favorite of mine in the beginning years of my business since this type of retirement plan is good for self-employed people and small business owners with no or very few employees. The benefits are in a SEP, you can put up to 25% of your net earnings pretax or $56,000 yeah, that’s $56,000, whichever is less. So this can really result in a nice income tax savings. But the not so good side of a SEP for a business owner is that they must contribute the same percentage of their salary into a SEP for each eligible employee. So this means if you contribute 10% or even 25% of your compensation into a SEP plan, you must also contribute that same 10 – 25% of each eligible employee’s compensation into that plan for them as well. And the bad side about this is they have absolutely no skin in the game and a SEP and they can take it out anytime they want to and do whatever they want to with that contribution you made for them, even though you meant it for their retirement. So while a SEP IRA plan can be a great plan, there are other plans as well that may be better and we’re also going to be talking about a solo business 401k later if you have a few full time employees.
Mary Jo: The third retirement option for our small employer is the Simple IRA. This is best for businesses with more than two to three employees, up to around 20, based on our experience, but it can also work for larger businesses with up to a hundred employees. The simple plan stands for Savings Incentive Match Plan for Employees, if you were curious. And no wonder they need an acronym for it, it’s pretty complex. The contribution limits are up to $13,000 per person in 2019. There’s also a catchup contribution of $3,000 if you’re 50 or older. So if both you and your spouse work in a small business, which many do, as long as each one of your salaries is at least $13,000 or more, you can both contribute the full $13,000, or $16,000 each if you’re both over 50, to a Simple IRA Plan. This will result in a lot of tax savings, as well as providing a bright future for retirement. Also, for your employees, unlike the SEP IRA, the contribution burden isn’t solely on you. Employees can contribute through salary deferral, but employers are generally required to make either matching contributions to employee accounts of up to 3% of employee compensation or fixed contributions of 2% to every eligible employee. The key here is if you want the flexibility of only matching a contribution, then the 3% option is best. If you choose the lower 2% funding option as the employer, you are required to make this contribution every year whether the employee contributes or not. Simple IRA contribution limits are significantly lower than a SEP IRA or a solo 401k. However, if you end up having to make mandatory contributions to employee accounts, this can be expensive, especially if you have a large number of employees who participate. But we have found that in most Simple IRAs, most employees choose not to participate. But as the small business owner you can. If the employee chooses not to participate, you don’t have to put in anything.
Bob: So I find, Mary Jo, in these simple IRAs, it’s actually a lot cheaper than the SEP IRA because you really don’t have to put in anything if your employees choose not to. If you wanted a SEP and you wanted to put in 25%, you’d have to come up with 25% for your employees. Well here, the most is 3%.
Mary Jo: That’s right. And you know, we talk a lot about if your spouse is working in the business, but I do want to clarify, I think you have to be able to prove that your spouse actually has a role and that they’re performing some contribution to the business because the IRS has the potential to follow up and check in on that. So you have to have some trails there.
Bob: And you don’t want to mess with the IRS.
Mary Jo: No, you don’t.
Bob: Ever! The fourth retirement option that we’re going to talk about is what we mentioned earlier is a solo 401k and it’s a lot like a SEP IRA, which allows for a very large pretax contribution that can save thousands on your income taxes. But the difference between the Solo 401k and the SEP IRA is that Solo allows for a catch up provision for business owners over 50 so this can amount to quite a bit in tax savings if you can put that much money in. So you just think about this, if you can put the max into that Solo 401k, or $56,000 plus an additional $6,000 if you’re over 50, think about how much income taxes that could save you. I mean, that’s a substantial amount, especially if you’re in a higher bracket, say like 25% to 30%, Mary Jo. Say you put $60k in, you know, and you’re in the 30% bracket, that’s an $18,000 tax savings.
Mary Jo: That can add up, most definitely, over time. And the fifth retirement option, finally, that we want to talk about is the Defined Benefit Plan. The first ones that we’ve identified are what we called contribution plans, but this last one is what’s known as a Defined Benefit Plan. This plan is for those who really want to sock it away and save thousands of dollars in income taxes now and for their future retirement income later, and they can afford to do it. It’s best for a self employed person with no or just a few employees who have a very high income and they want to save a lot. Say, for example, up to $225,000 per tax year on an ongoing basis until they hit the contribution limits. The contribution limits, these are calculated based on the benefit you’ll receive at retirement, your age, and your expected investment returns. That is one of the things that you have to understand about this plan is those contribution limits. They have to be calculated by an actuary.
Bob: I want to say something cause I’ve done a lot of these Defined Benefit Plans, especially for those in the Eagle Ford shale oil and gas, Mary Jo. You know, the older you are, that’s where you could get up to that high contribution limit. What we’re talking about like $225,000. So this defined benefit plan is geared toward those, like we’ve said, that really want to put a lot away and have a higher income and want to see a substantial tax savings. Because, can you imagine if you can put that kind of money in pretax, what the tax savings are? It’s enormous.
Mary Jo: We talk a lot about the small business owners and a lot of them are your laborers, your contractors, your tradesmen, but they’re also attorneys and doctors that are small business owners, and this plan is really good for those types of earners. Maybe those that are behind the eight ball who haven’t saved and they really need to do some heavy duty savings at the last minute. So, you find that this type of plan is attractive in those situations. In general, the annual benefit for a participant under a Defined Benefit Plan cannot exceed the lesser of 100% of the participant’s average compensation for his or her highest three consecutive calendar years or $225,000 for 2019. The employee benefit, if you have employees, you generally offer this plan to them and make contributions on their behalf based on their age and salary. So, it’s a pretty heavy burden to the employer. If you’re self employed and looking to establish a traditional pension plan for yourself, this is a good option. However, you have got to understand these plans are expensive. They have a high setup and high annual fees.
Bob: But can I say something in the middle there?
Mary Jo: Sure, Bob.
Bob: They’re expensive. They have a high setup in annual fees, but the fees are much cheaper than the income tax.
Mary Jo: That’s true.
Bob: I mean, you can save yourself $50,000 or $60,000 in income taxes.
Mary Jo: It puts things in perspective.
Bob: Exactly. It’s, you know, it’s 10% of that.
Mary Jo: If you have employees, that’s double the fees and you’ll have to contribute on their behalf. They also carry a, as we were talking about earlier, a heavy administrative burden each year and they require a commitment to fund the plan with a certain amount per year. And if you need to change that amount, you’ll have to pay additional administrative fees to do so. The upside is that you can stash a lot of cash in these. So, if you’re fairly close to retirement and earning a high income that you know you’ll need to maintain, that allows you to save a significant amount every year. We’re talking $50,000 to $80,000 or even more up to the limit of $225,000. You might consider using this plan to supercharge your savings efforts.
Bob: Yeah, it’s like I said before, Mary Jo, can you imagine how much income tax this can save a small business owner? I mean, what’s really great about this Defined Benefit Plan is you can also contribute the maximum to the first four plans we talked about on today’s podcast, which are called Defined Contribution Plans. So, you can do both. Don’t forget, you may even be able to double these contributions if your spouse works in the business with you. I’ve seen income tax savings of $50,000 even up to $100,000 by combining a contribution plan like we discussed in those first four with a defined benefit plan like this last one, if you’re eligible and you make a high enough income.
Mary Jo: And you know Bob, one of the things that you’ve got to think about when it comes to small business owners – but it’s pretty much everybody – it’s hard to say when you’re younger. You have so many family obligations. The children come in, you got to send them to college or trade schools or what have you, and it’s really not until the kids leave the house and the business has been around for a considerable amount of time that you feel like you’re in a position that you can actually save. So this type of plan is ideal for somebody that finds themselves in that kind of a situation. We’ve gone over a lot. It’s a lot to consider. And when choosing the retirement plan for your small business, it’s important to work with a qualified CPA® determine which plan or combination of plans suits your needs best. There are pros and cons of all the different types of plans we’ve talked about. We just wanted to give you a taste of what’s out there on today’s podcast, but there are a lot of rules that you need to weigh – weigh seriously – that we don’t have time to cover in today’s episode. The important thing is to start with some sort of savings plan for your retirement, and start it today. Now, let’s look briefly at some ways to protect you from those concerns like getting hurt on the job. That may keep you up at night. You know, it’s a big concern for a lot of small business owners. We’re going to look at this through the use of disability and general liability insurance.
Bob: Human capital is your ability to earn money in the future. So, if you depend on your ability to continue to earn money, and this is something that really needs protecting. A lot is riding on your ability to earn, including your retirement, your kid’s education, paying those bills such as the mortgage, etc. And since the majority of small business owners or laborers of some sort, this is really the biggest risk they face is getting injured. If not on the job, they’re likely to be injured in an accident traveling to or from the job cause that’s the cost of doing this type of work.
Mary Jo: So just think about this. What happens if you get injured on the job, become disabled and you’re no longer able to perform this same type of physical labor? The what you’re good at. You’re no longer able to earn money and you don’t have any more human capital, unless maybe you can reinvent yourself or learn a new trade. What happens to your business if you become disabled? What is left to sell? Nothing. You were the business. The business got customers based on your personal reputation and from those you’ve done work for in the past. Once you’re injured, this tends to dry up.
Bob: So this is where disability insurance comes in because disability insurance can provide that income in the event you can’t work and earn money due to a disability. There’s the short term disability policy that pays a portion of your salary for a short period of time, typically three to six months, and then there’s what we call longterm disability. So you combine these two and that pays a salary for a longer period, typically a period of over six months. We did a whole podcast on this. We were going to refer back to podcast number 36 and 37 on “Planning For Incapacity”, but another big risk that impacts small business owners is liability and there’s many forms and liability. Thus, the need for what we call general liability insurance.
Mary Jo: So what is general liability insurance? General liability insurance, sometimes called business liability insurance and commercial liability insurance, provides coverage for your business against claims of bodily injury, damage to property, personal injury, and associated medical costs that goes with that. You may ask, “Why do I need general liability insurance?” As a business owner, you should make sure your business is properly protected against the risk of unforeseen events. Having general liability insurance coverage protects your business against third party claims of bodily injury or damage to someone else’s property. However, it does not protect your own personal property. This section explains what our business general liability insurance offers. You should consider general liability insurance if you or your employees interact with clients face to face; if you visit a client’s place of work or clients visit yours; if you have access to a client’s equipment, for example, if you’re an IT professional, you should be covered against potential claims with IT Business liability insurance; if you represent your client’s business; or if you use third party locations for any business related activities. For example, are you a subcontractor or professional craftsmen such as an architect? You’re on other people’s job site as doing the nature of your business. You should look into business liability insurance for your specific type of business. For example, as advisors, we have in place “Errors And Omissions Insurance”. It’s a necessary part of doing business and giving advice to others. We live in South Central Texas, and if you listen to the radio, you watch TV, you drive down the highway and look at the billboards, we are prone to litigation in this state and it’s not going away.
Bob: That’s the truth.
Mary Jo: So you do need to have this protection.
Bob: Again. So general liability insurance, it’s going to cover things like bodily injury, damage to a third party’s property, personal injury, electronic data liability, medical expenses, attorney defense costs. That’s a big one.
Mary Jo: Yeah.
Bob: And actions of your full time employees and temporary staff. But here’s some things that doesn’t cover. It doesn’t cover your property, vehicles and boats, personal identifiable information, professional services, employee injury or workers’ comp, intent to injure, coverage outside of a policy period, or known claims prior to the start of a policy.
Mary Jo: One last major risk for the small business owner we’ll cover today. It’s getting paid in cash. Is there a risk to this? Is cash king?
Bob: No, cash is not king, especially when you under-report your income to the IRS because it’s against the law or your work comes in spurts and you can’t prove your income levels. So, steer clear of getting paid in cash. It can especially hurt you if you needed a business loan or you want to get a home mortgage. It can impact your credit rating. Both are important when applying for any kind of credit. So, you want to consider one of the biggest risks of underreporting your income is going to impact your earnings history for future social security payments. So keep in mind that your social security benefit is based on your highest 35 earning years, and if you’re getting paid in cash, that’s not gonna count towards that. So, this is a great reason to make sure you’re working with a good tax preparer and really leveraging all of benefits of business ownership but also skirting the many risks as best as you can. In closing, worrying about your future and being concerned about it, that’s normal. It’s part of being a business owner. Fortunately, there are plenty of smart moves you can make now to prepare for the future and maybe help you sleep better at night. If you have any questions on how to get started with any of this, please feel free to call Mary Jo or I at CIS Wealth Management Group. Our phone number during business hours is (830) 609-6986 or you can go to our website at ciswealth.com. In the upper right hand corner, there’s a little tab that you can click called “Meet With An Advisor” and you can make an appointment to talk to Mary Jo or I during business hours. That’s all for today.
Mary Jo: You’ve been listening to Christian Financial Perspectives. Join us next week as we explore more about how to apply biblical wisdom to your financial situations.
Bob: To make sure you don’t miss any of our podcasts, you can subscribe to Christian Financial Perspectives on iTunes, Google Play, or Stitcher. To learn more about integrating your faith with your finances, visit out website at ciswealth.com or call 830-609-6986.
Mary Jo: That’s all for now until next week.
Comments from today’s show are for informational purposes only and not to be considered investment advice or recommendations to buy or sell any company that may have been mentioned or discussed. The opinions expressed are solely those of the hosts, Bob Barber and Mary Jo Lyons. Bob and Mary Jo do not provide tax advice and encourage you to seek guidance from a tax professional. Investment advisory services offered through Christian Investment Advisors Inc. DBA CIS Wealth Management Group, a registered investment advisor.