As a wealth management strategist for more than 30 years, I advise clients on how to build and balance their three pools of money. Retirement planning isn't just a matter of saving money; it's a matter of investing money and allocating resources in a way that delivers the best return. So the goal is to get the longest compounding curve out of the assets that are taxed the least.
Unfortunately, not enough people implement a net after-tax plan early enough to generate the assets they'll need to have the kind of retirement they want — or even to have a solid retirement at all. This is especially true of small-business owners, who are often so consumed with the demands of operating the business that they fail to plan for the future.
Plan for the End Right from the Start
A detailed exit strategy should be a part of every business plan. But it isn't enough to map out an exit strategy for the business — you need one for yourself, too. In fact, if you start your own business, it's even more important to factor in retirement planning than it would be if you simply kept working at a job somewhere. You'll no longer have access to your employer's plan because now you are your employer.
Getting started isn't easy. I get that. When you launch a business, your instinct is to plow every spare second, and every spare cent, right back into that business to try to build a solid foundation. Building up funds for retirement is in part a function of cash flow, and when cash flow is tight, the tendency is to cut what seems to be the most distant need.
But saving something is always better than saving nothing. Ideally, you should try to save 15% of your gross income yearly; but if you can't spare that much, start with 5%. Just be sure you're committed to increasing the amount a little every year as your cash flow improves.
Use that Flow to Fill Those Pools
Once your business is established and you've been able to bump up your savings to that 15% target, it's important to have a fully integrated retirement plan. The goal is to diversify your savings so that you maximize the amount of after-tax income you can access in retirement.
That's where the three pools of money come in. Briefly, they are:
- Qualified retirement plan assets: These are traditional IRAs, pensions and 401(k) plans. They offer short-term benefits in the form of tax deductions, but the long-term downside is that the income from these will be taxable in retirement.
- Nonqualified investments: These include things like stocks, bonds, mutual funds and CDs. They provide liquidity, flexibility and cash flow.
- Tax-deferred retirement assets: Roth IRAs and cash-value life insurance fall under this category. They offset short-term slow growth with the greatest long-term gain in the form of tax-free retirement income.
It's important to understand that the three pools of money are in that order, based on how you'll use them in retirement, not on how you should accumulate them. Ideally, you should be building all three pools strategically throughout the time that you're building your business.
If anything, because pool 3 potentially offers the greatest long-term benefit, you should consider starting with that one, then concentrate on building pools 1 and 2. Once you have enough liquidity and reserves in place — pool 2, mostly — you can start funding more into both pool 1 and pool 3, both of which offer liability protection against creditors, which also makes them attractive to small-business owners.
Now, when it's time to retire, you should draw from pool 1 and pool 2 first, since those still have tax liabilities. Meanwhile, pool 3 could continue to grow until it's as big and deep as an Olympic-size swimming pool. And all of that money could be tax-free when it's time to relax and enjoy it after a career of hard work.
Jay E. Hochheiser is President and CEO of Hochheiser, Deutsch & Company, Inc., and author of The Entrepreneur's Guide to Achieving Financial Freedom.Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). 355 Lexington Avenue, 9th. Floor, New York, NY 10017-6603, 212-541-8800. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. Hochheiser, Deutsch & Company is not an affiliate or subsidiary of PAS or Guardian. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. This information should be relied upon only when coordinated with individual professional advice. Links to external sites are provided for your convenience in locating related information and services. Guardian, its subsidiaries, agents, and employees expressly disclaim any responsibility for and do not maintain, control, recommend, or endorse third-party sites, organizations, products, or services, and make no representation as to the completeness, suitability, or quality thereof. CA Insurance License #0F04261 2019-73283 Exp.1/21