The goal of many business owners is to start and grow a business with the hopes of one day monetizing it, either for themselves or their heirs. In fact, according to the second quarter 2023 BizBuySell Insight Report, 56% of business owners have an exit plan and half of those are actively selling or expecting to sell by 2024.
As a financial professional, you know that it’s important for your client to put a strategy into place now to manage the proceeds from the sale. This is especially important when the sale of the business is the culmination of a career, and the beginning of your client’s retirement.
Most business owners will be heavily reliant on the proceeds from the sale of their businesses to fund their retirements. According to the 2022 MassMutual Business Owner Perspectives Study, only 46% of business owners believe they are on track with their retirement savings and 65% have less than $500,000 saved in their retirement accounts.
You’ll also certainly want to discuss longevity with your business-owning clients. With medical advances, they should expect a long retirement — longer than generations before them. Depending on the age at which your clients sell their businesses and begin retirement, they may live for decades following retirement. However, only 54% of business owners believe their retirement nest egg will last more than 10 years.1
One good approach is for your business-owner client to plan for their spouse to live the longest. Help the client set aside a percentage of the sale proceeds that would remain untouched until their spouse needs it. You may want to consider life insurance for this role.
If they have children, be sure those offspring are already accounted for in estate planning or the business succession plan. If not, you may want to suggest that the client consider establishing a trust to transfer assets to the next generation. The client might also consider using a life insurance policy, with children as named beneficiaries, to transfer assets to them after the client’s death.
Creating an income strategy
When thinking about covering fixed living expenses, such as housing, food, clothing, transportation, insurance, and the like, many people rely on Social Security and traditional qualified plans, like a 401(k) or pension. Small business owners may have the challenge of not having sufficient sources of income in retirement and foresee selling their business as a way to fund their retirement.
However, if your client is selling a business, they most likely won’t be able to depend on it to offer a predictable amount of future retirement income. And the same is true for equity investments, particularly if they are unfortunate enough to retire during a bear market. If they do want more guaranteed income for life, one financial product can do that — an annuity.
Annuities such as an immediate income annuity, can offer benefits similar to those of a traditional corporate pension. It will produce a dependable stream of retirement income that can continue as long as the client lives, or as long as the client and their partner lives. The client can elect to receive income on a monthly, quarterly, semi-annual, or annual basis, and the amount of each payment will be fixed.
Before income payments begin, the client funds the annuity by making a purchase payment or payments. Unlike qualified retirement plans, there is no IRS cap on contributions to a nonqualified annuity, and purchase payments are not income tax deductible.
From a taxation perspective, the benefit of receiving income distributions throughout one’s life, allows the benefit of not having your payments taxed all upfront. Defined as an exclusion ratio, part of each annuity income payment received represents a return of non-taxable investment (or basis) in the contract, while the balance of each payment represents taxable income. The exclusion ratio is determined by dividing the investment in the annuity contract (or the portion of the contract that is annuitized) by the expected return, or total payments received.
Discussing an annuity as an income solution for your client may be beneficial to them as an annuity is the only personal financial product that offers an income that can’t be outlived. This benefit is especially appealing as longevity continues to increase.
- “Planning for The Unexpected Survey” commissioned by MassMutual and conducted by The Business Journal, 2022.
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