The following is adapted from The Entrepreneur’s Guide to Financial Well-Being.
As an entrepreneur, the first phase of your financial planning will be growing your wealth. But as your investment strategy evolves and your wealth grows, you enter an even more complex realm: wealth enhancement and advanced planning.
At this stage, planning should be about more than an investment strategy.
If you’re like many entrepreneurs, you separate your work life and personal life when it comes to creating wealth. You hand your money over to a broker or adviser to invest it, not thinking about how the money has been pulled out of your business and taxed, and is now worth 30 to 40 percent less than before you took it out.
What if you thought more broadly about how your resources could be used? Instead of compartmentalizing your finances, for example, consider what opportunities exist to invest through a pre-tax retirement plan to shelter that money and leverage it now while you are in a high tax bracket. Then you’d take it out in the future at a lower tax rate.
Integration makes sense, but too often, when entrepreneurs leave their corporate jobs to strike out on their own, they keep an “employee mentality” toward their finances. They do what they’ve always done. Some entrepreneurs are focused on an outdated design, and they can’t see the possibility of a beautiful integration of systems.
Successful wealth enhancement is about being proactive. It’s about giving increased consideration to federal, state, and payroll taxes all the time, not just at the end of the year (or quarter). It’s about knowing how to use retirement accounts. As a business owner, you can do things like design and implement your own 401(k) and determine whether you want to match employee contributions and/or have profit sharing.
Enhanced Plans and Retirement Accounts
Successful entrepreneurs are paid well. They have a high W-2 wage and high distributions, and they pay a significant amount of taxes. But again, entrepreneurs often do what they did as employees—get paid and then use a 401(k) to shelter $19,000 (which is the upper limit in 2019 for those under age fifty, after which it goes to $25,000).
If, as an entrepreneur, you take a step back and ask how you can take a long-term view to enhance your wealth, you can design a plan to shelter more income from high levels of taxation. Countless business owners are wary of pension plans because of the idea that many companies fail because they can’t meet pension plan obligations. However, a combination of a cash balance plan and a 401(k) plan allows entrepreneurs to save more of their own money (up to 95% of total contributions) if implemented correctly.
To maximize savings, you must also understand how to use the different types of retirement accounts. For example, let’s say your husband decides to leave his job to be a stay-at-home dad with your two girls as they enter junior high.
Your high income puts you above the limit to take a deductible IRA contribution for your husband, and it also prohibits him from making a Roth IRA contribution. But he can make a nondeductible IRA contribution and immediately roll it into a Roth IRA.
Your husband can continue to build his savings in the Roth account through these yearly “back-door” contributions. The contributions are taxed upfront, but the growth and withdrawals are not, setting the family up to enhance their wealth in the future. This strategy is highly complex, so you’ll need an adviser who knows this arena well.
Employee benefits are another focus point for wealth enhancement. Strategies such as a profit-sharing plan increase the amount you can save. So do two additional benefits: flexible spending accounts and health savings accounts (FSAs and HSAs).
These work like savings accounts for qualifying medical expenses. Employees contribute pretax, reducing their tax liability. Funds can be used for deductibles or copays and for qualifying prescriptions and medical equipment. (An FSA allows income to be deferred for childcare.) FSAs and HSAs have a number of differences, including how they are structured and the contribution limits. Both allow you and your employees to shelter income while you’re in the highest-earning tax brackets.
HSA balances may accumulate and be invested for growth and use in the future, while FSAs are “use it or lose it” pretax accounts. When using an FSA with an HSA, it is called a limited FSA and has special limitations to comply with IRS rules.
Not all HSA plans are the same, and in fact, some are expensive. Working with an adviser who can point out these differences and efficiently guide you, and even possibly manage your HSA account options, is a way to use your adviser to your advantage.
Meanwhile, you may have heard of health reimbursement accounts, or HRAs. HRAs are for employer contributions only. Employees are reimbursed by the plan after presenting receipts. While they are not a wealth enhancement strategy, entrepreneurs may want to explore them as an employer-based benefit.
The Power of a Skillful, Trustworthy Adviser
When you’re a stressed, overworked entrepreneur, it’s understandable that you would be tempted by easy, “instant” solutions offered by payroll and insurance companies. Unfortunately, easy doesn’t necessarily translate into efficient.
It’s my belief and experience that you can save more money for yourself and your employees by ensuring you are not in prepackaged retirement plans. The strategies I’ve described in this article are extremely valuable—but they are not simple.
To implement them, you need to work with an adviser who knows what they’re doing. I decided to earn a master’s degree in employee benefits law to ensure I could help my entrepreneurial clients take advantage of every opportunity to save and grow wealth. When I work with a client, I not only help design the right plan for them, I help them communicate the benefits of their plan to their employees.
My dad always told me, “You can delegate authority, but you can never delegate responsibility.” As a boss, you have a fiduciary duty in choosing plans for employees.
A fiduciary adviser has robust processes in place to ensure entrepreneurs meet these duties and reduce or eliminate liability. Selecting and monitoring investments is a significant responsibility that most entrepreneurs believe is alleviated by using their existing adviser. In fact, many advisers may not be responsible for the very thing for which the entrepreneur has engaged them.
You don’t know what you don’t know, and you need someone who does.