As a small business owner or entrepreneur, you have probably put most of your energy and finances into growing your company over the years. And rightfully so – focusing on business growth is important. However, as retirement age approaches, funding a secure retirement becomes increasingly urgent.
Unlike salaried employees, small business owners do not have access to traditional pension plans or employer-matched 401k programs. As an entrepreneur, the responsibility of saving and investing for retirement income falls squarely on your shoulders. Yet juggling that along with running a business is no easy task.
This often leaves many business owners in a tough spot when they exit their companies. Many have to continue working well past the typical retirement age just to make ends meet for financial security. Others are forced to sell their life’s work for far less than they anticipated just to generate some retirement funds. And some unfortunate folks have to do both!
The good news is that as a business owner, you have flexible options when it comes to retirement planning that regular employees do not. One such option that is growing in popularity is annuities – essentially private pensions that provide guaranteed lifetime income.
This article will explore how annuities work, their unique benefits for entrepreneurs, and how to incorporate them into your long-term retirement plans.
The Retirement Planning Challenge for Business Owners
Studies show that roughly 60% of small business owners have no dedicated retirement savings put aside. The average retirement funds for an entrepreneur is about $100,000 – far below what is considered adequate to maintain a lifestyle in retirement years.
There are several key reasons why retirement preparation tends to fall behind for those who are self-employed:
No Access To Pension Plans Or 401ks
Unlike company employees, entrepreneurs do not have access to company-sponsored pension plans or 401k programs that provide matching funds. Building retirement funds or a personal pension falls entirely to the business owner.
Difficulty Saving Consistently
For small and mid-sized companies, cash flow varies from year to year. Setting aside money regularly for retirement is challenging when facing periods of low revenue or if reinvestment is needed back into the business.
Reliance On Selling The Business
Many self-employed individuals plan to sell their companies to fund the bulk of their retirement. However, only 20% of small businesses put up for sale find a buyer. And those that do sell often get far less value than expected.
The end result is that few small business owners have systematically built their retirement funds over time. With rapidly improving health care allowing retirement spans of 20 years or more, this lack of consistent saving puts many entrepreneurs in financial risk later in life.
How Can Annuities Help Bridge the Retirement Gap?
Annuities are essentially private pensions – contracts with insurance companies that allow you to build funds that can later pay out guaranteed lifetime income. They share similarities with other tax-deferred retirement accounts like 401ks and IRAs. However, annuities offer unique advantages specifically helpful to entrepreneurs facing retirement.
A few of these include:
- Flexibility to make lump sum contributions in high revenue years
- Principal protection and guaranteed growth rates
- Lifetime guaranteed income that you cannot outlive
- Ability to pass remaining assets to heirs as beneficiary payouts – Death benefit!
- Growth over Tax-deferred basis, allowing faster accumulation of assets
- No IRS contribution limits, allowing entrepreneurs to rapidly fund substantial accounts if desired
How do Annuities work?
In simple terms, here is how it works…
You enter into a contract with an insurance provider to purchase an annuity. This involves making either a single lump-sum payment or a series of ongoing contributions over a period of years. The funds in the annuity account grow in a tax-deferred manner at a guaranteed interest rate set by the insurance company. A Typical guaranteed rate tends to range from 3-5% annually.
Then, once you hit your target retirement date, the accumulated annuity value can be structured to pay out regular lifetime income. Annuity companies have entire actuarial teams that calculate your precise income amounts based on your account value, age, gender, and other attributes. This ensures you can never outlive your funds no matter how long you live.
Any remaining annuity value upon the owner’s death goes to named beneficiaries. This allows entrepreneurs to leave legacy assets to heirs if some annuity value remains later in life.
Clearly, annuities offer a way for business owners to create their own private pensions. When used strategically, they can help provide retirement security and peace of mind for entrepreneurs.
Using Annuities to Fund Your Retirement
While every small business owner’s situation is unique, there are some best practices to follow when building an annuity-based retirement strategy.
Purchase Early to Maximize Growth
The earlier you begin funding annuities, the more their tax-deferred growth can work in your favor. Consider purchasing first annuities in your 40s or 50s to allow 20+ years of compounded gains. This will lead to substantially larger retirement account values.
Make Lump Sum Contributions
During high revenue years, make additional lump sum contributions to quickly build account values. This allows maximizing your annuity holdings when the business is thriving.
Structure as Deferred Annuities
When purchasing, opt for deferred annuities that allow you to delay taking income payments until a set retirement date. Then structure payouts to begin when you actually expect to step away from running your company daily. This strategy results in higher income amounts at retirement.
Select Lifetime Payout Options
Upon activation at retirement, select lifetime guaranteed income payouts. This protects against outliving funds no matter how long you live. Adding annual inflation bumps to income can help maintain purchasing power over decades.
Be sure to name business partners, spouses or children as beneficiaries to annuity contracts. This allows any leftover annuity value to pass directly to successors after the owner’s lifetime.
Diversify Across Providers
Consider building positions with several highly-rated insurance companies. Spreading funds across separate annuity contracts adds an extra level of protection to lifetime guarantees.
The point here is developing an annuity purchase plan early in your career designed to fully fund retirement through compounded, tax deferred growth.
With proper strategy, annuities can provide assets and guaranteed income to cover fixed retirement expenses throughout your later years.
Using Annuities If Behind on Retirement Saving!
If you find yourself well into your 50s with inadequate retirement savings, annuities can also still provide real benefits. While you may have missed years of compounded growth, even funding annuities 10 or 15 years before retirement can generate meaningful income.
Additionally, immediate annuities are available that begin lifetime income payouts as soon as 13 months after purchase. So even if nearing retirement, annuities remain an option to lock in guaranteed income starting in the short term.
A mix of deferred and immediate annuities can allow both the accumulation of additional assets and also initiation of reliable income streams in parallel. Work with a financial professional advisor to structure a customized plan based on your specific stage of retirement funding.
Additional Benefits of Using Annuities
Beyond reliable lifetime income and tax-deferred growth, annuities offer entrepreneurs several other unique benefits that contribute to retirement peace-of-mind including:
Insurance against Living Too Long
Average life expectancies now exceed 85+ years for men and 87+ years for women. With lengthening lifespans, the risk of outliving retirement assets grows year after year. Annuities with lifetime payouts ensure you can never outlive income, no matter how long you live.
Protection Against Disability & Chronic Illness
Many annuities offer riders that provide access to accumulated funds without penalty if you become disabled or suffer specified critical illnesses before retirement age. This can prevent the need to tap retirement assets just when they are needed most.
Legacy Planning and Estate Transfer
Through designating beneficiaries, annuities guarantee any remaining assets after your lifetime will pass directly to heirs according to your selection. Annuity with Death Benefits allows the efficient transfer of wealth as part of your business succession plans.
Backing of Insurance Companies
All annuity income and growth guarantees are backed by the financial strength of insurance carriers. Major insurers have senior claims on assets and managing risk is their core business, thus improving the chances of them making good on decades-long annuity promises.
Using Annuities for Funding Business Succession
Beyond funding the business owner’s retirement, annuities can also facilitate overall business succession and transfer plans in several helpful ways:
- Naming the business itself as the owner of annuity contracts with the entrepreneur as annuitant can allow accessing accumulated values for funding succession while separating personal asset
- Establishing annuity-based income streams helps provide steady funding for entrepreneurs during transitional phases
- Annuities give business owners options to access a portion of their company’s value over time without full sale of the operation!
Incorporating annuities into the overall transfer planning allows entrepreneurs to tap portions of their business valuation to support retirement while minimizing disruption and securing future income.
Growing Concerns with Annuities!
While annuities carry clear advantages for entrepreneurs, some common concerns occasionally arise that are important to address.
Early Withdrawal Penalties
Some annuities assess surrender charges if assets are accessed early. These are similar to CD penalties, and allow the insurer to recoup acquisition costs if you exit early. However, this risk can be mitigated via two methods:
- Only purchase annuities with 7-10 year surrender term. With longer investing horizons the penalties expire before retirement assets are typically needed anyway.
- When initiating annuity income payments, the surrender penalties end. So by activating lifetime payouts at target retirement age, charges can be avoided by design.
Should Not Be 100% of Retirement Portfolio
No financial vehicle – including annuities – should make up your entire retirement holdings. As with any asset, diversifying across product types protects from overconcentration in any one instrument. Annuities should be incorporated as a piece of your overall strategy, not the entirety of your approach.
Annuities at first glance can seem complex, particularly for business owners lacking deep financial backgrounds. However, at their core annuities simply allow growing assets tax-free and later pay that accumulated value as dependable, predictable income. Working with a financial advisor well versed in these products can help navigate any perceived intricacy!
- What types of retirement plans and insurance products should I consider as a small business owner?
As a small business owner, you have several options when it comes to retirement planning that both allow you to save for retirement and provide income in your later years. Annuities are popular insurance products that function similarly to pensions by providing guaranteed lifetime income. They allow you to make either lump sum or ongoing contributions that grow tax-deferred, which you can later convert to steady retirement income. Annuities can provide protection against risks like outliving savings or market declines. Other options like 401ks, IRAs, life insurance, and long term care insurance should also be considered as part of your overall retirement plan. I’d be happy to discuss the pros and cons of various retirement plan and insurance products to help you determine what mix is right for you and key employees.
- How do annuities differ from other options when planning for retirement?
Annuities have some unique advantages over other vehicles when preparing for retirement. Not only do they provide reliable, guaranteed income for life, annuities allow flexibility to contribute lump sums when business is thriving. They offer principal protection against stock market risk and have tax deferred growth on gains. Many also have riders to access funds if needed for long term care costs. Annuities do have some downsides such as surrender fees but overall can provide security in retirement other products cannot. We should discuss your cash flow, risk tolerance and estate plans to decide if annuities have a place among holdings like stocks, mutual funds and real estate. My advice is to diversify with a mix of vehicles best suited to your situation.
- What annuity options may work for funding my own retirement while also providing business continuity?
Several annuity strategies can help business owners plan for both personal retirement and business succession planning needs. For retirement income, deferred annuities allow tax-deferred savings now which are later converted to lifetime income streams to fund your financial future. For business continuity, owners can be named as the annuitant with the business itself as the owner. This allows assets inside the contract to accumulate tax deferred to fund succession plans or transitions to key employees. Lifetime annuity payments with living benefits can also provide owners with steady income during transitional phases or retirement. Alternatively, annuities may be gifted to key employees as an incentive while providing owners income via 1035 exchanges of existing policies. There are various options so please reach out to discuss your specific situation in detail.