Category Archives: Small business

Ideas to help small business owners build financial security.

The Critical Role of Life Insurance in Financial Planning

Posted on September 3, 2010 | Leave a comment

As comprehensive wealth managers, we believe that protecting risks through insurance is a foundational element of a financial plan. Investments are important and draw most of our ongoing focus, but without insurance, savings and investments can be lost.

As author Nick Murray writes, “We insure against what can go wrong in order to acquire the luxury of investing for what can go right.”

Before you consider how much you need to save to retire comfortably or fund a child’s education, it’s important to make sure that your risks are protected in case something does go wrong. Unfortunately, we all know someone who has died well before their time. We’re not all as invincible as we like to pretend.

It’s not a pleasant scenario to think about, but not doing so can have serious consequences.

Roughly 70 million adult Americans have no life insurance coverage at all. Many others have employer provided coverage that provides a nominal death benefit—i.e. $50,000 or one or two times annual salary. In most cases, especially with people who are not near the end of their career, this is not enough to provide needed financial security to those left behind.

Consider your needs based on the following three scenarios:

You’re Married With Kids and a Mortgage. Having kids and debt are the most obvious reasons to own life insurance. If you and your income were suddenly gone, would your spouse and kids be okay financially? Life insurance replaces lost income to help make sure those who depend on you will be provided for, no matter what life throws your way. You don’t want to force your spouse to find someone else to help pay bills, save for retirement and put the kids through college. Inexpensive term life insurance can protect against this risk until your family is secure enough to get by without your income.

You’re a Small Business Owner. Life insurance can help protect your business in a number of ways in the event you, your partner, or a key employee dies prematurely. A buy-sell agreement funded with life insurance allows surviving business owners to buy the company interests of a deceased business owner at a previously agreed-on price. Again, relatively inexpensive term life insurance can protect against this risk.

You’re Likely to Owe Estate Tax. If you’ve built significant net worth, a little planning can save a lot of money in estate taxes. Especially if your net worth is relatively illiquid (i.e., lots of real estate or business value) paying the estate tax bill may be difficult. Estate tax payments are due nine months after death. In many situations, affluent individuals can benefit from the use of an Irrevocable Life Insurance Trust (ILIT) to create liquidity at the right time and save heirs and executors a lot of headaches. In this case, a permanent insurance policy may make a lot of sense.

CPA and IRA expert Ed Slott preaches that life insurance is the best leverage of the tax code: “A small amount of money can create huge benefit that is income tax and estate tax free as long as it is set up outside the estate.”

The amount of net worth excluded from estate tax could be as little as $1,000,000 per person in 2011 if Congress allows tax law to proceed as currently written. Anything above $1,000,000 could be exposed federal tax of 55% in addition to state tax.

To adequately address estate planning needs, it’s important to seek legal advice in the context of an overall financial plan.

How Much Insurance Do You Need?

Decisions about the amount and type of life insurance coverage should come after answering the following questions.

  • If I and/or my spouse dies, how much will be required to replace my/our earnings?
  • Do I need permanent or temporary coverage?
  • Who should be the beneficiary of my insurance policy?
  • Should this insurance be held inside our outside my estate?
  • What is the financial condition of the insurance carrier?

You can get a general sense of how well you are protected by using this life insurance needs calculator. Or, we are happy to review your situation to see how insurance fits into your overall financial plan.

P.S., After initially posting this article, we saw this interesting table:

The chances of premature death are greater than people realize.

Chance of a 25-year-old man not living another 15 years 1 in 42
. . . . . 35-year-old man 1 in 21
. . . . . 45-year-old man 1 in 10
. . . . . 25-year-old woman 1 in 83
. . . . . 35-year-old woman 1 in 36
. . . . . 45-year-old woman 1 in 17

Source: Human Mortality Database, which combines data from US Census and National Center for Health Statistics 2005

~ Brooks, Hughes & Jones, Partners in Wealth Management — Gary Brooks, CFP®, Allyn Hughes, CFP®, CLU, ChFC, Nancy Jones, CFP® — Tacoma, WA

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Exit plan a crucial aspect to small business ownership

Posted on September 3, 2010 | Leave a comment
Gary’s monthly column in The News Tribune was published in today’s (9/3/10) business section.

http://www.thenewstribune.com/2010/09/03/1326289/exit-plan-a-crucial-aspect-to.html#ixzz0yU1OlMta

By Gary Brooks

Business owners by nature are courageous folks who are comfortable taking risks. But there is one thing that seems to commonly invoke fear for them—the exit strategy.

The exit strategy is a critical element of financial security and yet, even many leading edge baby boomers with retirement in sight have no formal idea how they will get the most out of their business.

Business owners often let inertia stall their progress for one of four reasons:

  1. the business defines their life and they can’t imagine a different situation,
  2. they dread what may happen to the business without their guidance and the goodwill they’ve built with customers or clients,
  3. they fear potential conflict in transitioning leadership of the business,
  4. and/or they have anxiety about defining the value of the business and the financial realities it presents in funding the next stage in life.

Any of these concerns, left to linger, can limit the business owner’s options for an acceptable outcome.

THE SOLUTION

Business owners who are most successful with exit strategies have common attributes. They actively plan several years in advance. They perform due diligence with accountants, appraisers and industry experts to accurately value the business. They incorporate business value and transition timing into a personal financial plan. They understand all their exit strategy options, choose the preferred path, and align all decisions with maximizing the probability of success with the chosen strategy.

Whether the business has made a fortune or is just moderately profitable, the most successful transitions follow one of three planned exit strategies—the groomed successor, sale to an unrelated party, or the managed wind down.

THE GROOMED SUCCESSOR

Indentifying new shareholders among family, employees, or even friendly competition, can ease many fears. It allows the owner to preserve what is important to them and presents the least interruption to the business.

It’s not always simple to design an internal transition, but it may be the most satisfying option. The key is to start the grooming process early so that clear expectations and timelines can be defined, including how to structure the financial aspect of the transition. In some cases, successful businesses grow beyond an internal successor’s ability to afford to purchase it.

ACQUISITION BY AN UNRELATED PARTY

The first step in preparing to review offers for the business is to have a strong understanding of its value. When the right measure of value is determined, it’s important to manage the business toward improving that specific measure as much as possible.

The established value, and ultimately, the sale price, can have significant impact on taxes, retirement income, estate planning, and more inter-related elements of the owner’s financial situation. Sudden liquid wealth presents a whole different set of challenges.

THE MANAGED WIND DOWN

If the business is past its prime or in a dying industry, an option is to take as much earnings as possible out of the business as personal income rather than reinvesting in the company. This way, rather than expecting a future sale to generate a lump sum to retire on, the sum can be accumulated over time.

One risk is that this may be a tax-inefficient way to build financial security. Ordinary personal income tax rates would likely be more harmful than capital gains taxes that could be applied to a lump sum or installment plan sale.

A LESS-DESIRABLE OPTION

For too many business owners, it is a fourth option—closure and liquidation—that becomes the default choice. This often happens for reasons outside the owner’s control such as death, disability for themselves or a family member, or a change in demand (profits) due to the economy, industry evolution, and so on.

The best way to prevent settling for the default choice is to identify the facts, get good advice and use both to support a clearly emotional decision.

Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a Registered Investment Adviser in Old Town Tacoma. Reach him at gary@bhjadvisors.com.

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How to Avoid the 5 Big Investing & Asset Protection Pitfalls of Small Business Owners

Posted on May 13, 2010 | Leave a comment

Many small business owners demonstrate five important traits that often make them successful entrepreneurs but lower their chances of achieving their retirement goals:

Risk #1 – Reinvestment

Because their financial future is often directly related to the value of their company, many small business owners tend to reinvest all excess capital back into their business, rather than investing a portion of it in more diversified retirement portfolios or programs. This habit may increase short-term returns (if the business is successful), but it also increases short- and long-term risks.

Solution # 1 – Diversification

Many financial planners and investment professionals worry when a client has more than 10% of investable assets in a single investment. Understanding how to intelligently take profits out of your business and reallocate them to other investment choices could be the most important action you take to increase your chances of long-term success.

Risk #2 – Business Value = Retirement Income

Many business owners don’t know how much money they will need to retire comfortably. Because they often assume that most of their retirement assets will come from the sale of their business, their retirement income is often directly connnected with the success or failure of selling their business. This creates large amounts of risk for the business owner.

Solution #2 – Planning

A exit strategy for the business should be in mind long before an ownership transition. Planning allows for target goals to be created. With a target, it’s much more obvious when course corrections are necessary along the way. Planning will also expose options and opportunities that may not have been considered to align your entire financial ecosystem (your financial resources, both personal and professional) with your goals.

Risk #3 – Poor Investment Managemnet

When business owners invest for retirement, they often take too much risk. Because they are used to company-specific risk, they often disregard the fact that asset classes perform in unpredictable cycles, and they fail to sufficiently diversifying their holdings.

Solution #3 – Allocation

The best investmnet managers allocate assets across a wide variety of investment classes, work to manage their investment expenses and maintain ongoing strategic balance. They don’t try to market time or chase the next investment fad. Following these principles, along with making sure that you consistently invest toward your goals may dramatically improve the likelihood of meeting your goals.

Risk #4 – The Temptation of Success

After most small business owners retire, they often continute to take too much risk with their retirement plan investments because they think that their entrepreneurial skills have provided them with good training to be successful investors.

Solution #4 – Assistance

The skills that it takes to be a successful business owner are very different than those used for investing. Intelligent investment guidance can help business owners increase return expectations and lower risk by combining asset allocation wisdom with understanding of advanced opportunities.

Risk #5 – The Myth of Invincibility

Many small business owners are convinced that they will be healthy enough to continue to lead their business until they choose to leave. They also think that they will be able to leave on their own tersm – when the value of the business is at its peak. More often than not, this is untrue as health issues – including disability and death – often force an owner to sell the business at a less than desired price.

Solution #5 – Protection

Two tools – a formal succession plan and insurance-funded agreements – can help reduce the risks that the value of your business will be damaged if you can no longer manage it. Creating a succession plan, with consistently updated agreements for the sale of the business, allows you to determine a fair sale price and simplify your transition away from the business. Insurance can be used to both fund the sale of the firm or to protect against illiquidity at death or disability.

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Regardless of the exit stategy timeline and maturity of the business, owners should at the very least work with an experienced professional to:

  • Complete an in-depth analysis of goals and plans for the future
  • Provide a roadmap of preferred options to achieve goals
  • Complete an analysis to identify whether or not assets and earnings power are protected and in position to grow without taking excessive risk
  • Implement investment management strategies aligned with retirement income goals
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Net Operating Loss Can Be Valuable

Posted on November 10, 2009 | Leave a comment

Gary wrote a guest column for the South Sound Business Examiner focusing on the Roth IRA conversion opportunity specifically for business owners.

Small business owners with negative taxable income due to a net operating loss in their business can convert pre-tax retirement account dollars to a Roth IRA tax free.

Click on the thumbnail image to read the article.

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Posted in Financial planning, Investments, Retirement, Small business, Taxes

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