Small Business Owner - how to build retirement wealth

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JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Small Business Owner - how to build retirement wealth

Post by JBTX » Tue May 15, 2018 2:58 pm

As a piggy back to this:

viewtopic.php?f=1&t=246289

I know a small business owner, early 40's, 25ish employees, doing well, top income tax bracket (S Corp). Business is doing great but hasn't built up much retirement assets.

Goals are twofold:

1. Build up some retirement wealth in most tax efficient way possible over next 20+ years
2. Wants to put some sort of "skin in the game" for 2 key employees - an incentive/payoff 20+ years down the road if they stick around. I guess that means either no payout if they leave before, or perhaps significantly reduced payout, depending on structure.

Let's say for argument's sake #1 goal is $2 million+, give or take (obviously more is better) and for number 2, something less than or equal to #1.

Obviously, amounts for 1 and 2 are dependent upon how much he contributes annual over 20ish years, and whatever investment returns happen to be.

Options:

A.Whole Life: They got some whole life quotes for 20 years. Best I can tell the numbers are pretty awful, in terms of a wealth accumulation vehicle. These don't adjust for inflation, and it appears that returns are around 2.5 to 3.0% IRR (which I think is equivalent to a "real" post inflation return). I am unclear if contributions are to be made by company, or paid directly by business owner - and what the tax consequences are. At one point I think agent told them contributions would be tax deductible for company - I have no idea if that is correct.

B.Increase 401k contributions by switching to safe harbor plan. Owners contribution is restricted, the thought was a safe harbor plan would let him accumulate more. However is salary is high, so I don't think the amount would be that much more to get to $18,500 annual tax deferred max. So he only improves his situation marginally but then pays a lot more in employee match to other non-key employees (putting aside whether that is the right thing to do, or not, for the other employees)

C.Add some sort of Defined contribution/Cash Balance plan to existing 401k plan. This would allow him to defer substantial amounts, but the downside is profit sharing for 25 employees is expensive. It sounds like this set up is more likely to be used by doctors/dentists in small shops with only a few additional moderately paid employees.

D.Mega Backdoor Roth 401k. I have no idea whether current 401k allows in-service distributions. They will probably change 401k plan anyway, so perhaps this could be changed? Would this allow owner/employees to put in up to $50K+ each year, with the amounts over $18,500 being non-deductible, but eligible for Roth IRA conversion? Can you do this if the plan is NOT safe harbor? What are the considerations here?

E. Plain Jane Taxable investment account - this is pretty obvious alternative.

Those are all options for #1 above. Are they any others that may be better?

I really have no idea how to accomplish #2 above. Any ideas are welcome.

staythecourse
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Joined: Mon Jan 03, 2011 9:40 am

Re: Small Business Owner - how to build retirement wealth

Post by staythecourse » Tue May 15, 2018 5:45 pm

So your talking about 4 million give or take over 20 years. That doesn't require any fancy moves does it if one is making enough income to be at the highest tax bracket? All that it requires is the same boglehead style investing approach.

The big elephant in the room that needs to be figured out is what is the exit plan? Is the plan to sell the business? Is the plan to continue to own until you die and have others do all the heavy lifting when you step down from day to day activities? If it is the former then the friend needs to talk to other folks who have been successful exiting this way in his field and get a plan in place to do the same over the next 20 years. If it is the latter then he needs to figure out how to identify and keep those folks on board, likely some minority ownership.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

JBTX
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Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Tue May 15, 2018 7:11 pm

staythecourse wrote:
Tue May 15, 2018 5:45 pm
So your talking about 4 million give or take over 20 years. That doesn't require any fancy moves does it if one is making enough income to be at the highest tax bracket? All that it requires is the same boglehead style investing approach.

The big elephant in the room that needs to be figured out is what is the exit plan? Is the plan to sell the business? Is the plan to continue to own until you die and have others do all the heavy lifting when you step down from day to day activities? If it is the former then the friend needs to talk to other folks who have been successful exiting this way in his field and get a plan in place to do the same over the next 20 years. If it is the latter then he needs to figure out how to identify and keep those folks on board, likely some minority ownership.

Good luck.
As to $4M. Maybe. Ultimately the balance will be whatever it will be.

I suspect the answer will be there aren't any free lunches out there, and no magical plans company plans that are going to give some unusual tax advantage one way or other.

At this point, the business mostly runs itself without the owner. So for now the plan is for him to keep the business indefinitely - its spits out nice cash flow with little involvement. Why sell it? it is unlikely it would sell for the value of its future cash flows.

Minority ownership is an option and has been discussed, but it comes with complications.

I am certainly familiar with standard qualified retirement plans, but not so much certain insurance products or non qualified plans. Or Cash balance plans. It is likely that in such a scenario none of these make sense, but I need to understand them and be able to explain why they don't. Because there are people pitching them. I'm googling around figuring out bits and pieces but wondered if anybody here had any perspective.

Scrapr
Posts: 76
Joined: Sun May 09, 2010 9:19 am

Re: Small Business Owner - how to build retirement wealth

Post by Scrapr » Tue May 15, 2018 9:42 pm

JBTX wrote:
Tue May 15, 2018 7:11 pm
staythecourse wrote:
Tue May 15, 2018 5:45 pm
At this point, the business mostly runs itself without the owner. So for now the plan is for him to keep the business indefinitely - its spits out nice cash flow with little involvement. Why sell it? it is unlikely it would sell for the value of its future cash flows.
Why wouldn't a business sell for discounted cash flow? That is kind of the way it works. EBITDA x X amount. Typically 1-5 but sometimes much higher in special situations

Why not set up a bonus/profit sharing with the 2 employees. Clean. Simple. Incent the employees to stick around

Spirit Rider
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Joined: Fri Mar 02, 2007 2:39 pm

Re: Small Business Owner - how to build retirement wealth

Post by Spirit Rider » Tue May 15, 2018 10:40 pm

  1. Whole Life: This is never an efficient way to build wealth.
  2. Safe Harbor 401k: With the minimum 100%/3% and 50%/2% match would allow someone with the maximum plan compensation (2018 = $275K) to receive an $11K match. So for 2018 that would be $18.5K + $11K = $39.5K. At age 50, that will increase by the catch-up amount (2018 = $6K).
  3. Cash balance plan: Is a defined benefit plan that defines the promised benefit in terms of a stated account balance. This will have a lot of staff costs.
  4. Mega Backdoor Roth 401k: Is subject to Actual Contribution Percentage (ACP) testing of after-tax contributions even in a Safe Harbor 401k. HCEs will be limited based on the average contribution percentage of non-HCEs
  5. Plain Jane Taxable investment account: Is always a good option. You can make a case that after you have a certain base of tax-deferred investments, you do not give up a lot with tax efficient placement.
  6. A possible option you might not be aware of is a Safe Harbor 401k with the New Comparability method of profit sharing. You use a profit sharing contribution instead of an employer match. You then can create employee groups that can receive different profit sharing percentages. Additional cross-testing is required, but a default 5% PS contribution is a PS safe harbor of sorts. This very likely could allow the owner and key employees to max the full $55K
This employer should really find a local low cost Third Party Administrator (TPA). They can review all the options that would make sense for this business such as the New Comparability method. The key is to find one that would not be hooked up with an advisor pushing expensive funds. Rather one that would work with you to select a good mix of funds for the employees.

JBTX
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Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 12:17 am

Spirit Rider wrote:
Tue May 15, 2018 10:40 pm
  1. Whole Life: This is never an efficient way to build wealth.
  2. Safe Harbor 401k: With the minimum 100%/3% and 50%/2% match would allow someone with the maximum plan compensation (2018 = $275K) to receive an $11K match. So for 2018 that would be $18.5K + $11K = $39.5K. At age 50, that will increase by the catch-up amount (2018 = $6K).
  3. Cash balance plan: Is a defined benefit plan that defines the promised benefit in terms of a stated account balance. This will have a lot of staff costs.
What do you mean by staff costs?
[*]Mega Backdoor Roth 401k: Is subject to Actual Contribution Percentage (ACP) testing of after-tax contributions even in a Safe Harbor 401k. HCEs will be limited based on the average contribution percentage of non-HCEs
Sorry I’m not following any of that. Will you explain further?
[*]Plain Jane Taxable investment account: Is always a good option. You can make a case that after you have a certain base of tax-deferred investments, you do not give up a lot with tax efficient placement.
[*]A possible option you might not be aware of is a Safe Harbor 401k with the New Comparability method of profit sharing. You use a profit sharing contribution instead of an employer match. You then can create employee groups that can receive different profit sharing percentages. Additional cross-testing is required, but a default 5% PS contribution is a PS safe harbor of sorts. This very likely could allow the owner and key employees to max the full $55K[/list]
This employer should really find a local low cost Third Party Administrator (TPA). They can review all the options that would make sense for this business such as the New Comparability method. The key is to find one that would not be hooked up with an advisor pushing expensive funds. Rather one that would work with you to select a good mix of funds for the employees.
I will look into new comparability. Thanks!

Edit: this looks very interesting. So I take it with such a plan the owner gets to $55k max mainly by profit sharing instead of employee match?

As to the 5% quasi safe harbor - is that 5% of Employee compensation? That would be even more than the 3% across the board safe harbor match. For an owner looking to maximize his savings and not so much every body else’s doesn’t this kind of go the wrong way?
Last edited by JBTX on Wed May 16, 2018 1:20 am, edited 1 time in total.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 1:02 am

Scrapr wrote:
Tue May 15, 2018 9:42 pm
JBTX wrote:
Tue May 15, 2018 7:11 pm
staythecourse wrote:
Tue May 15, 2018 5:45 pm
At this point, the business mostly runs itself without the owner. So for now the plan is for him to keep the business indefinitely - its spits out nice cash flow with little involvement. Why sell it? it is unlikely it would sell for the value of its future cash flows.
Why wouldn't a business sell for discounted cash flow? That is kind of the way it works. EBITDA x X amount. Typically 1-5 but sometimes much higher in special situations

Why not set up a bonus/profit sharing with the 2 employees. Clean. Simple. Incent the employees to stick around
Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little Involvement?

Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?

clacy
Posts: 106
Joined: Wed Apr 20, 2011 8:50 pm

Re: Small Business Owner - how to build retirement wealth

Post by clacy » Wed May 16, 2018 1:23 am

JBTX wrote:
Wed May 16, 2018 1:02 am
Scrapr wrote:
Tue May 15, 2018 9:42 pm
JBTX wrote:
Tue May 15, 2018 7:11 pm
staythecourse wrote:
Tue May 15, 2018 5:45 pm
At this point, the business mostly runs itself without the owner. So for now the plan is for him to keep the business indefinitely - its spits out nice cash flow with little involvement. Why sell it? it is unlikely it would sell for the value of its future cash flows.
Why wouldn't a business sell for discounted cash flow? That is kind of the way it works. EBITDA x X amount. Typically 1-5 but sometimes much higher in special situations

Why not set up a bonus/profit sharing with the 2 employees. Clean. Simple. Incent the employees to stick around
Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?


Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?

There are lots of reasons to sell, but if your guy doesn't want to sell, it's a moot point. The way you describe it.... business on auto pilot, very little effort, good cashflow, low stress, etc, etc..... I can see why he wouldn't want to sell it. You probably can't earn that same return in a balanced portfolio. With that said, business environments can and do change quickly, so locking in profits by selling has it's good points too.

Anyway, he may want to look into phantom stock. That way the two key employees could keep the carrot of working for the next 20 years, and either apply that "equity" towards a buyout of the owner in 10-20 years, or participate in the profit if he sells to another buyer (or pay dividends over time to the key employees).

Scrapr
Posts: 76
Joined: Sun May 09, 2010 9:19 am

Re: Small Business Owner - how to build retirement wealth

Post by Scrapr » Wed May 16, 2018 1:40 am

[/quote]

Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?

Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?
[/quote]

Things can happen over 20 years. New competitors enter, merge, die off. Technology changes industries. There is no garuntee on future profits. What if one of these key employee dies, or gets a "fabulous" offer,obtains an inheritance of 10 million, or hits their number and retires. Then your friend has to go hands on back in the business. I have trained 3 Ops managers. It is very time intensive on translating all the knowledge in your own brain. Perhaps there is high cost to maintain the operation. Intel pours billions in a plant that is obsolete in a few years. From the outside it can look easy. But I can assure you founders think about "the baby" all the time

Sometimes cash is king. Just to take some risk off the table

You can structure a bonus plan however you want. Vesting period, stock ownership, etc. I'd ask what is important to the key persons and tailor something there. So you don't provide nanny services as part of the plan, but their kids are grown & gone.

I don't know anything about the tax advantaged plans. So really don't have anything to offer there

I have been listening to a podcast called Built to Sell. Long form interviews of owners that have decided or were forced to sell. Very good discussion

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 1:45 am

clacy wrote:
Wed May 16, 2018 1:23 am
JBTX wrote:
Wed May 16, 2018 1:02 am
Scrapr wrote:
Tue May 15, 2018 9:42 pm
JBTX wrote:
Tue May 15, 2018 7:11 pm
staythecourse wrote:
Tue May 15, 2018 5:45 pm
At this point, the business mostly runs itself without the owner. So for now the plan is for him to keep the business indefinitely - its spits out nice cash flow with little involvement. Why sell it? it is unlikely it would sell for the value of its future cash flows.
Why wouldn't a business sell for discounted cash flow? That is kind of the way it works. EBITDA x X amount. Typically 1-5 but sometimes much higher in special situations

Why not set up a bonus/profit sharing with the 2 employees. Clean. Simple. Incent the employees to stick around
Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?


Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?

There are lots of reasons to sell, but if your guy doesn't want to sell, it's a moot point. The way you describe it.... business on auto pilot, very little effort, good cashflow, low stress, etc, etc..... I can see why he wouldn't want to sell it. You probably can't earn that same return in a balanced portfolio. With that said, business environments can and do change quickly, so locking in profits by selling has it's good points too.

Anyway, he may want to look into phantom stock. That way the two key employees could keep the carrot of working for the next 20 years, and either apply that "equity" towards a buyout of the owner in 10-20 years, or participate in the profit if he sells to another buyer (or pay dividends over time to the key employees).
You’ve hit the nail about the business. Using any sort of reasonable SWR, he would have to get well into 8 figures to fund their current lifestyle. Much easier just to keep the business, but there are risks. It is a business that should hold up reasonably well in a weak economy. The biggest risks are customer specific.

Phantom stock looks interesting and could work. It is an S Corp so apparently need to set it up correctly. Where does one go to get advice on how to set such things up?

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 1:54 am

Scrapr wrote:
Wed May 16, 2018 1:40 am

Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?

Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?
Things can happen over 20 years. New competitors enter, merge, die off. Technology changes industries. There is no garuntee on future profits. What if one of these key employee dies, or gets a "fabulous" offer,obtains an inheritance of 10 million, or hits their number and retires. Then your friend has to go hands on back in the business. I have trained 3 Ops managers. It is very time intensive on translating all the knowledge in your own brain. Perhaps there is high cost to maintain the operation. Intel pours billions in a plant that is obsolete in a few years. From the outside it can look easy. But I can assure you founders think about "the baby" all the time

Sometimes cash is king. Just to take some risk off the table

You can structure a bonus plan however you want. Vesting period, stock ownership, etc. I'd ask what is important to the key persons and tailor something there. So you don't provide nanny services as part of the plan, but their kids are grown & gone.

I don't know anything about the tax advantaged plans. So really don't have anything to offer there

I have been listening to a podcast called Built to Sell. Long form interviews of owners that have decided or were forced to sell. Very good discussion
Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now.

Yes anything could happen with 2 employees. One is my wife. She isn’t going anywhere. Worst case I could probably step in. The other is in operations, thus the desire to create long term incentives.

clacy
Posts: 106
Joined: Wed Apr 20, 2011 8:50 pm

Re: Small Business Owner - how to build retirement wealth

Post by clacy » Wed May 16, 2018 2:00 am

JBTX wrote:
Wed May 16, 2018 1:45 am
clacy wrote:
Wed May 16, 2018 1:23 am
JBTX wrote:
Wed May 16, 2018 1:02 am
Scrapr wrote:
Tue May 15, 2018 9:42 pm
JBTX wrote:
Tue May 15, 2018 7:11 pm


At this point, the business mostly runs itself without the owner. So for now the plan is for him to keep the business indefinitely - its spits out nice cash flow with little involvement. Why sell it? it is unlikely it would sell for the value of its future cash flows.
Why wouldn't a business sell for discounted cash flow? That is kind of the way it works. EBITDA x X amount. Typically 1-5 but sometimes much higher in special situations

Why not set up a bonus/profit sharing with the 2 employees. Clean. Simple. Incent the employees to stick around
Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?


Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?

There are lots of reasons to sell, but if your guy doesn't want to sell, it's a moot point. The way you describe it.... business on auto pilot, very little effort, good cashflow, low stress, etc, etc..... I can see why he wouldn't want to sell it. You probably can't earn that same return in a balanced portfolio. With that said, business environments can and do change quickly, so locking in profits by selling has it's good points too.

Anyway, he may want to look into phantom stock. That way the two key employees could keep the carrot of working for the next 20 years, and either apply that "equity" towards a buyout of the owner in 10-20 years, or participate in the profit if he sells to another buyer (or pay dividends over time to the key employees).
You’ve hit the nail about the business. Using any sort of reasonable SWR, he would have to get well into 8 figures to fund their current lifestyle. Much easier just to keep the business, but there are risks. It is a business that should hold up reasonably well in a weak economy. The biggest risks are customer specific.

Phantom stock looks interesting and could work. It is an S Corp so apparently need to set it up correctly. Where does one go to get advice on how to set such things up?

A good corporate attorney should be able to handle that. They don't work cheap, but this is the type of thing you need professional help to do the right way, from the start.

Spirit Rider
Posts: 7825
Joined: Fri Mar 02, 2007 2:39 pm

Re: Small Business Owner - how to build retirement wealth

Post by Spirit Rider » Wed May 16, 2018 9:35 am

JBTX wrote:
Wed May 16, 2018 12:17 am
Spirit Rider wrote:
Tue May 15, 2018 10:40 pm
Cash balance plan: Is a defined benefit plan that defines the promised benefit in terms of a stated account balance. This will have a lot of staff costs.
What do you mean by staff costs?
The employer contributions for all employees
[*]Mega Backdoor Roth 401k: Is subject to Actual Contribution Percentage (ACP) testing of after-tax contributions even in a Safe Harbor 401k. HCEs will be limited based on the average contribution percentage of non-HCEs
Sorry I’m not following any of that. Will you explain further?
The ACP test will compare the average contribution % of HCEs and non-HCEs. Usually this means HCE% = average non-HCE% + 2%
I will look into new comparability. Thanks!

Edit: this looks very interesting. So I take it with such a plan the owner gets to $55k max mainly by profit sharing instead of employee match?

As to the 5% quasi safe harbor - is that 5% of Employee compensation? That would be even more than the 3% across the board safe harbor match. For an owner looking to maximize his savings and not so much every body else’s doesn’t this kind of go the wrong way?
An owner and other HCEs does not just get to freely maximize their contributions at the expense of the non-HCE employees. Whether owners like it or not, tax-advantaged retirement plans are a public policy to benefit employees not owners. Owners and othe HCEs don't need government tax benefits nearly as much as that median income employee. This is the reason for all of the 401k anti-discrimination rules. Otherwise many owners would give employees nothing.

As my dearly departed mom would say; "share the wealth." In my example, with the 5% profit sharing contribution to all employees, the owner and key employees could get a 13%+ profit sharing contribution (subject to cross-testing). What more do you want?

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 10:27 am

Spirit Rider wrote:
Wed May 16, 2018 9:35 am
JBTX wrote:
Wed May 16, 2018 12:17 am
Spirit Rider wrote:
Tue May 15, 2018 10:40 pm
Cash balance plan: Is a defined benefit plan that defines the promised benefit in terms of a stated account balance. This will have a lot of staff costs.
What do you mean by staff costs?
The employer contributions for all employees
[*]Mega Backdoor Roth 401k: Is subject to Actual Contribution Percentage (ACP) testing of after-tax contributions even in a Safe Harbor 401k. HCEs will be limited based on the average contribution percentage of non-HCEs
Sorry I’m not following any of that. Will you explain further?
The ACP test will compare the average contribution % of HCEs and non-HCEs. Usually this means HCE% = average non-HCE% + 2%
I guess what puzzles me about this is beyond Boglehead world, I would think non deductible 401k contributions would be rare. I have read numerous threads in this forum about posters doing mega backdoor Roths. My assumption would be that some, perhaps most, are HCEs. I would think most of them would be running into this testing problem too. As you describe it, I would think almost nobody would qualify because they are rare and typically only done by HCEs?


I will look into new comparability. Thanks!

Edit: this looks very interesting. So I take it with such a plan the owner gets to $55k max mainly by profit sharing instead of employee match?

As to the 5% quasi safe harbor - is that 5% of Employee compensation? That would be even more than the 3% across the board safe harbor match. For an owner looking to maximize his savings and not so much every body else’s doesn’t this kind of go the wrong way?
An owner and other HCEs does not just get to freely maximize their contributions at the expense of the non-HCE employees. Whether owners like it or not, tax-advantaged retirement plans are a public policy to benefit employees not owners. Owners and othe HCEs don't need government tax benefits nearly as much as that median income employee. This is the reason for all of the 401k anti-discrimination rules. Otherwise many owners would give employees nothing.

As my dearly departed mom would say; "share the wealth." In my example, with the 5% profit sharing contribution to all employees, the owner and key employees could get a 13%+ profit sharing contribution (subject to cross-testing). What more do you want?
I understand what you are saying and conceptually agree, but I am advising him and don’t feel it is my place to push too hard on how he runs is business. From what I understand his employees are paid better than average for the industry and have better benefits and even get bonuses which is not typical. At this point it is a choice between him saving more for retirement or putting more money in employees retirement account.

A 5% profit share for all non HCE would probably add $50k of expense. Paying an additional $50k in order to personally save another $40k in his 401k is a pretty high price.

Would the profit sharing apply to all employees or only ones that are participating and contributing to the plan?

Thanks for your answers. They have been extremely helpful!

Spirit Rider
Posts: 7825
Joined: Fri Mar 02, 2007 2:39 pm

Re: Small Business Owner - how to build retirement wealth

Post by Spirit Rider » Wed May 16, 2018 11:08 am

JBTX wrote:
Wed May 16, 2018 10:27 am
I guess what puzzles me about this is beyond Boglehead world, I would think non deductible 401k contributions would be rare. I have read numerous threads in this forum about posters doing mega backdoor Roths. My assumption would be that some, perhaps most, are HCEs. I would think most of them would be running into this testing problem too. As you describe it, I would think almost nobody would qualify because they are rare and typically only done by HCEs?
Five years ago (Mar 2013), employee after-tax contributions were rare for all plans (4%), but not so much for plans > 2500 participants (29%). Then in IRS Notice 2014-54 (Sep 2014), they acquiesced to split rollovers (after-tax contributions -> rIRA and pre-tax earnings -> tIRA). This facilitated the use of the so-called Mega Backdoor Roth.

This has resulted in an explosion of plans offering employee after-tax contributions and In-plan Roth Rollover (IRR) and/or in-service rollovers. They are far from rare now, with the majority of plans > 2500 participants and a substantial minority of plans > 500 participants offering these features.

A funny thing happened on the way to the forum in these larger plans. It turns out that substantial numbers of non-HCEs with $80K - $120K compensation were making after-tax contributions. When a non-HCE makes those contributions, they have the ability to make higher contribution %. This has resulted in non-HCE average contribution %, such that plans either pass ACP testing or limit HCEs to reasonable %.

However, they are still rare for plans < 100 participants. One-participant plans have shown some interest, because they are not subject to ACP testing. There is no one to discriminate against, since everyone is an owner.
Would the profit sharing apply to all employees or only ones that are participating and contributing to the plan?
Yes, by definition all employer non-elective contributions must be made regardless of whether the employee contributes.

The owner should still contact a TPA to see what the possible options are. Employee Fiduciary has been a recommended national low cost option, but there have been some reports that they are not the best for New Comparability calculations.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 11:30 am

Thanks again. This is really helpful. I’m always amazed the knowledge you have in this area.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Wed May 16, 2018 12:56 pm

Spirit Rider wrote:
Wed May 16, 2018 11:08 am
JBTX wrote:
Wed May 16, 2018 10:27 am
I guess what puzzles me about this is beyond Boglehead world, I would think non deductible 401k contributions would be rare. I have read numerous threads in this forum about posters doing mega backdoor Roths. My assumption would be that some, perhaps most, are HCEs. I would think most of them would be running into this testing problem too. As you describe it, I would think almost nobody would qualify because they are rare and typically only done by HCEs?
Five years ago (Mar 2013), employee after-tax contributions were rare for all plans (4%), but not so much for plans > 2500 participants (29%). Then in IRS Notice 2014-54 (Sep 2014), they acquiesced to split rollovers (after-tax contributions -> rIRA and pre-tax earnings -> tIRA). This facilitated the use of the so-called Mega Backdoor Roth.

This has resulted in an explosion of plans offering employee after-tax contributions and In-plan Roth Rollover (IRR) and/or in-service rollovers. They are far from rare now, with the majority of plans > 2500 participants and a substantial minority of plans > 500 participants offering these features.

A funny thing happened on the way to the forum in these larger plans. It turns out that substantial numbers of non-HCEs with $80K - $120K compensation were making after-tax contributions. When a non-HCE makes those contributions, they have the ability to make higher contribution %. This has resulted in non-HCE average contribution %, such that plans either pass ACP testing or limit HCEs to reasonable %.

However, they are still rare for plans < 100 participants. One-participant plans have shown some interest, because they are not subject to ACP testing. There is no one to discriminate against, since everyone is an owner.
Would the profit sharing apply to all employees or only ones that are participating and contributing to the plan?
Yes, by definition all employer non-elective contributions must be made regardless of whether the employee contributes.

The owner should still contact a TPA to see what the possible options are. Employee Fiduciary has been a recommended national low cost option, but there have been some reports that they are not the best for New Comparability calculations.
One more question: it seems like what I am seeing elsewhere is the profit sharing is in addition to the employer match, not instead of it.

https://www.employeefiduciary.com/blog/ ... l-business
What is a gateway minimum contribution?

Before a 401(k) plan can cross-test a new comparability contribution, it must first allocate a gateway minimum contribution to all non-HCEs. This contribution prevents an employer from passing the general test by giving large contributions (as a % of compensation) to young, low-wage workers while giving miniscule contributions to other non-HCEs.

The gateway minimum contribution made to all plan non-HCEs must equal the lesser of:

one-third the highest contribution rate given to any HCE (based on the plan’s definition of compensation)

5% of the participant’s gross compensation

Generally, only non-HCEs eligible for the new comparability contribution must receive the gateway minimum contribution. However, any non-HCE that receives a safe harbor 3% non-elective or top heavy minimum contribution must also receive a gateway minimum contribution. This exception is noteworthy because small business 401k plans frequently combine new comparability and safe harbor 3% non-elective contributions to pass ADP/ACP and top heavy testing.
Also in some new comparability scenarios their advisor just sent me they had a new comparability scenario that was in addition to the employer match, not instead of.

What the guy said was none of the scenarios work great for us because there isn’t enough disparity between owners (owner and wife at low rate of pay) and all the non HCEs which mostly range between $50k and $100k. The results are a significant increase of employer contributions to get increased contribution for owner.

Spirit Rider
Posts: 7825
Joined: Fri Mar 02, 2007 2:39 pm

Re: Small Business Owner - how to build retirement wealth

Post by Spirit Rider » Wed May 16, 2018 2:52 pm

JBTX wrote:
Wed May 16, 2018 12:56 pm
One more question: it seems like what I am seeing elsewhere is the profit sharing is in addition to the employer match, not instead of it.

https://www.employeefiduciary.com/blog/ ... l-business
That is not correct. There is not even any mention of a match in your link. It is most efficient to replace a safe Harbor employer match with a Safe Harbor employer profit-sharing
What is a gateway minimum contribution?
This is the minimum PS contribution that satisfies the 1/3 or 5% requirement. This why it is better to have no match, because >= 3% PS contribution satisfies the ADP/ACP safe harbor. With a 4% PS Gateway Minimum Contribution (GMC), and $275K compensation the owner could receive a $275K * 12% (limit 4% * 3) = $33K PS contribution. With a 5% PS GMC and $182.5K compensation the owner could receive a $182.5K * 20% (no limit) = $36.5K PS contribution. Both of these would still be subject to cross-testing.
Also in some new comparability scenarios their advisor just sent me they had a new comparability scenario that was in addition to the employer match, not instead of.
I have not generally seen this.
What the guy said was none of the scenarios work great for us because there isn’t enough disparity between owners (owner and wife at low rate of pay) and all the non HCEs which mostly range between $50k and $100k. The results are a significant increase of employer contributions to get increased contribution for owner.
Any attempt to get additional contributions are going to be subject to the specifics of the employee census.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Thu May 17, 2018 5:26 pm

Spirit Rider wrote:
Wed May 16, 2018 2:52 pm
JBTX wrote:
Wed May 16, 2018 12:56 pm
One more question: it seems like what I am seeing elsewhere is the profit sharing is in addition to the employer match, not instead of it.

https://www.employeefiduciary.com/blog/ ... l-business
That is not correct. There is not even any mention of a match in your link. It is most efficient to replace a safe Harbor employer match with a Safe Harbor employer profit-sharing
What is a gateway minimum contribution?
This is the minimum PS contribution that satisfies the 1/3 or 5% requirement. This why it is better to have no match, because >= 3% PS contribution satisfies the ADP/ACP safe harbor. With a 4% PS Gateway Minimum Contribution (GMC), and $275K compensation the owner could receive a $275K * 12% (limit 4% * 3) = $33K PS contribution. With a 5% PS GMC and $182.5K compensation the owner could receive a $182.5K * 20% (no limit) = $36.5K PS contribution. Both of these would still be subject to cross-testing.
Also in some new comparability scenarios their advisor just sent me they had a new comparability scenario that was in addition to the employer match, not instead of.
I have not generally seen this.
What the guy said was none of the scenarios work great for us because there isn’t enough disparity between owners (owner and wife at low rate of pay) and all the non HCEs which mostly range between $50k and $100k. The results are a significant increase of employer contributions to get increased contribution for owner.
Any attempt to get additional contributions are going to be subject to the specifics of the employee census.

Interestingly, just heard today from TPA than under current plan the HCE’s will have to drop contribution level to about 4.0% because so few of Non HCEs are participating. All the more motivation to go to safe harbor plan or profit share.

Non HCEs are mostly technicians and a couple of admin. Only about 1/2 are participating and their percents are really low. In your experience if you go to a safe harbor of 100% of first 3% and 50% of next 2% (which is one of safe harbor options, I think) how much would that likely increase participation?

WhiteMaxima
Posts: 1000
Joined: Thu May 19, 2016 5:04 pm

Re: Small Business Owner - how to build retirement wealth

Post by WhiteMaxima » Thu May 17, 2018 5:35 pm

Grow you business and sell it to the highest bidder at certain point.

smitcat
Posts: 1273
Joined: Mon Nov 07, 2016 10:51 am

Re: Small Business Owner - how to build retirement wealth

Post by smitcat » Thu May 17, 2018 6:59 pm

JBTX wrote:
Wed May 16, 2018 1:54 am
Scrapr wrote:
Wed May 16, 2018 1:40 am

Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?

Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?
Things can happen over 20 years. New competitors enter, merge, die off. Technology changes industries. There is no garuntee on future profits. What if one of these key employee dies, or gets a "fabulous" offer,obtains an inheritance of 10 million, or hits their number and retires. Then your friend has to go hands on back in the business. I have trained 3 Ops managers. It is very time intensive on translating all the knowledge in your own brain. Perhaps there is high cost to maintain the operation. Intel pours billions in a plant that is obsolete in a few years. From the outside it can look easy. But I can assure you founders think about "the baby" all the time

Sometimes cash is king. Just to take some risk off the table

You can structure a bonus plan however you want. Vesting period, stock ownership, etc. I'd ask what is important to the key persons and tailor something there. So you don't provide nanny services as part of the plan, but their kids are grown & gone.

I don't know anything about the tax advantaged plans. So really don't have anything to offer there

I have been listening to a podcast called Built to Sell. Long form interviews of owners that have decided or were forced to sell. Very good discussion
Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now.

Yes anything could happen with 2 employees. One is my wife. She isn’t going anywhere. Worst case I could probably step in. The other is in operations, thus the desire to create long term incentives.
"Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now."

I got to this point reading this post and felt compelled to blurt out that no-one ever see's the decline of a company coming. They play the companies profit growth and then tend to ride it down until it is too late to sell at a decent profit - sometimes the decline comes very quickly with no real notice at all.
Declines can be completely out of the control of a company and/or within limited control that affords very little ability to mitigate the decline.
So I have been at more than one company that I had "a percentage of" which then slid down this track where initially my % times the value of the company at its peak was substantial - then within a year the value was near zero and one time the job went away as well.
Just to remain consistent (so call me wrong if you will but consistent) we have our own companies now and we intend to sell on the top and not rely on the profit remaining strong forever or attempting to time the top (sounds familiar perhaps).

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Thu May 17, 2018 7:13 pm

smitcat wrote:
Thu May 17, 2018 6:59 pm
JBTX wrote:
Wed May 16, 2018 1:54 am
Scrapr wrote:
Wed May 16, 2018 1:40 am

Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?

Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?
Things can happen over 20 years. New competitors enter, merge, die off. Technology changes industries. There is no garuntee on future profits. What if one of these key employee dies, or gets a "fabulous" offer,obtains an inheritance of 10 million, or hits their number and retires. Then your friend has to go hands on back in the business. I have trained 3 Ops managers. It is very time intensive on translating all the knowledge in your own brain. Perhaps there is high cost to maintain the operation. Intel pours billions in a plant that is obsolete in a few years. From the outside it can look easy. But I can assure you founders think about "the baby" all the time

Sometimes cash is king. Just to take some risk off the table

You can structure a bonus plan however you want. Vesting period, stock ownership, etc. I'd ask what is important to the key persons and tailor something there. So you don't provide nanny services as part of the plan, but their kids are grown & gone.

I don't know anything about the tax advantaged plans. So really don't have anything to offer there

I have been listening to a podcast called Built to Sell. Long form interviews of owners that have decided or were forced to sell. Very good discussion
Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now.

Yes anything could happen with 2 employees. One is my wife. She isn’t going anywhere. Worst case I could probably step in. The other is in operations, thus the desire to create long term incentives.
"Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now."

I got to this point reading this post and felt compelled to blurt out that no-one ever see's the decline of a company coming. They play the companies profit growth and then tend to ride it down until it is too late to sell at a decent profit - sometimes the decline comes very quickly with no real notice at all.
Declines can be completely out of the control of a company and/or within limited control that affords very little ability to mitigate the decline.
So I have been at more than one company that I had "a percentage of" which then slid down this track where initially my % times the value of the company at its peak was substantial - then within a year the value was near zero and one time the job went away as well.
Just to remain consistent (so call me wrong if you will but consistent) we have our own companies now and we intend to sell on the top and not rely on the profit remaining strong forever or attempting to time the top (sounds familiar perhaps).
Of course, there are no guarantees. Their biggest risks are major clients decide not to renew at end of contract.

But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000? That would mean you would have to live on $20 to $40, vs $100. I wouldn’t sell. That is a risk I’d take. I’m not sure why a Bogle head would sell an established profitable business at a 5 or 10 multiple then turn around and invest it in stocks at a 20-25 multiples.

smitcat
Posts: 1273
Joined: Mon Nov 07, 2016 10:51 am

Re: Small Business Owner - how to build retirement wealth

Post by smitcat » Fri May 18, 2018 6:06 am

JBTX wrote:
Thu May 17, 2018 7:13 pm
smitcat wrote:
Thu May 17, 2018 6:59 pm
JBTX wrote:
Wed May 16, 2018 1:54 am
Scrapr wrote:
Wed May 16, 2018 1:40 am

Why would owner sell for a multiple of 5 when he can hold on to it for 20 more years with little
Involvement?

Are you talking about a bonus/ps plan inside of a qualified retirement plan or just straight up
Additional compensation? How does a bonus plan that pays out now incent an employee to stick around 20 more years ?
Things can happen over 20 years. New competitors enter, merge, die off. Technology changes industries. There is no garuntee on future profits. What if one of these key employee dies, or gets a "fabulous" offer,obtains an inheritance of 10 million, or hits their number and retires. Then your friend has to go hands on back in the business. I have trained 3 Ops managers. It is very time intensive on translating all the knowledge in your own brain. Perhaps there is high cost to maintain the operation. Intel pours billions in a plant that is obsolete in a few years. From the outside it can look easy. But I can assure you founders think about "the baby" all the time

Sometimes cash is king. Just to take some risk off the table

You can structure a bonus plan however you want. Vesting period, stock ownership, etc. I'd ask what is important to the key persons and tailor something there. So you don't provide nanny services as part of the plan, but their kids are grown & gone.

I don't know anything about the tax advantaged plans. So really don't have anything to offer there

I have been listening to a podcast called Built to Sell. Long form interviews of owners that have decided or were forced to sell. Very good discussion
Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now.

Yes anything could happen with 2 employees. One is my wife. She isn’t going anywhere. Worst case I could probably step in. The other is in operations, thus the desire to create long term incentives.
"Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now."

I got to this point reading this post and felt compelled to blurt out that no-one ever see's the decline of a company coming. They play the companies profit growth and then tend to ride it down until it is too late to sell at a decent profit - sometimes the decline comes very quickly with no real notice at all.
Declines can be completely out of the control of a company and/or within limited control that affords very little ability to mitigate the decline.
So I have been at more than one company that I had "a percentage of" which then slid down this track where initially my % times the value of the company at its peak was substantial - then within a year the value was near zero and one time the job went away as well.
Just to remain consistent (so call me wrong if you will but consistent) we have our own companies now and we intend to sell on the top and not rely on the profit remaining strong forever or attempting to time the top (sounds familiar perhaps).
Of course, there are no guarantees. Their biggest risks are major clients decide not to renew at end of contract.

But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000? That would mean you would have to live on $20 to $40, vs $100. I wouldn’t sell. I’m not sure why a Bogle head would sell an established profitable business at a 5 or 10 multiple then turn around and invest it in stocks at a 20-25 multiples.
"But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000?"
Depends on the business - we take the closing costs of similar business or a similar size (cash flow) and start from there. For us with what we are doing now the target sale is at a 4X multiple.
"That would mean you would have to live on $20 to $40, vs $100"
With a largely profitable business the owner typically can easily live on the 1/5th to 1/4 number that you have identified. Since typically the taxes will be 33% or larger and savings will be in the area of 40% or more.
"That is a risk I’d take."
Perhaps that is a great idea now and perhaps not, too many variables that no one knows about. One of our large past employers went down unexpectedly when the 'many' banks we worked with did not pay their bills during the too big to fail fiasco. Lost 3,000+ employees with that one and with little notice - unless the business has an unusually high barrier of entry, locked patents and/or are bought there is always a turnover. That and potential regulatory changes, family 'surprises' , competition both domestic and foreign change and turnover are inevitable.
FWIW - the worst potential risks come when the business goes south as it takes your "investment", salary and career with it and if both spouses are in the business it takes both down.
What most do not realize is that with your own business worst case you could quickly end up with quite a large negative worth as opposed to nothing.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Fri May 18, 2018 8:07 am

smitcat wrote:
Fri May 18, 2018 6:06 am
JBTX wrote:
Thu May 17, 2018 7:13 pm
smitcat wrote:
Thu May 17, 2018 6:59 pm
JBTX wrote:
Wed May 16, 2018 1:54 am
Scrapr wrote:
Wed May 16, 2018 1:40 am


Things can happen over 20 years. New competitors enter, merge, die off. Technology changes industries. There is no garuntee on future profits. What if one of these key employee dies, or gets a "fabulous" offer,obtains an inheritance of 10 million, or hits their number and retires. Then your friend has to go hands on back in the business. I have trained 3 Ops managers. It is very time intensive on translating all the knowledge in your own brain. Perhaps there is high cost to maintain the operation. Intel pours billions in a plant that is obsolete in a few years. From the outside it can look easy. But I can assure you founders think about "the baby" all the time

Sometimes cash is king. Just to take some risk off the table

You can structure a bonus plan however you want. Vesting period, stock ownership, etc. I'd ask what is important to the key persons and tailor something there. So you don't provide nanny services as part of the plan, but their kids are grown & gone.

I don't know anything about the tax advantaged plans. So really don't have anything to offer there

I have been listening to a podcast called Built to Sell. Long form interviews of owners that have decided or were forced to sell. Very good discussion
Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now.

Yes anything could happen with 2 employees. One is my wife. She isn’t going anywhere. Worst case I could probably step in. The other is in operations, thus the desire to create long term incentives.
"Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now."

I got to this point reading this post and felt compelled to blurt out that no-one ever see's the decline of a company coming. They play the companies profit growth and then tend to ride it down until it is too late to sell at a decent profit - sometimes the decline comes very quickly with no real notice at all.
Declines can be completely out of the control of a company and/or within limited control that affords very little ability to mitigate the decline.
So I have been at more than one company that I had "a percentage of" which then slid down this track where initially my % times the value of the company at its peak was substantial - then within a year the value was near zero and one time the job went away as well.
Just to remain consistent (so call me wrong if you will but consistent) we have our own companies now and we intend to sell on the top and not rely on the profit remaining strong forever or attempting to time the top (sounds familiar perhaps).
Of course, there are no guarantees. Their biggest risks are major clients decide not to renew at end of contract.

But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000? That would mean you would have to live on $20 to $40, vs $100. I wouldn’t sell. I’m not sure why a Bogle head would sell an established profitable business at a 5 or 10 multiple then turn around and invest it in stocks at a 20-25 multiples.
"But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000?"
Depends on the business - we take the closing costs of similar business or a similar size (cash flow) and start from there. For us with what we are doing now the target sale is at a 4X multiple.
"That would mean you would have to live on $20 to $40, vs $100"
With a largely profitable business the owner typically can easily live on the 1/5th to 1/4 number that you have identified. Since typically the taxes will be 33% or larger and savings will be in the area of 40% or more.
"That is a risk I’d take."
Perhaps that is a great idea now and perhaps not, too many variables that no one knows about. One of our large past employers went down unexpectedly when the 'many' banks we worked with did not pay their bills during the too big to fail fiasco. Lost 3,000+ employees with that one and with little notice - unless the business has an unusually high barrier of entry, locked patents and/or are bought there is always a turnover. That and potential regulatory changes, family 'surprises' , competition both domestic and foreign change and turnover are inevitable.
FWIW - the worst potential risks come when the business goes south as it takes your "investment", salary and career with it and if both spouses are in the business it takes both down.
What most do not realize is that with your own business worst case you could quickly end up with quite a large negative worth as opposed to nothing.
I appreciate your perspective, but in this case I respectfully disagree, and more importantly he isn’t paying me to advise him to keep or sell his business. I am tasked with trying to figure out the best retirement plan options for him.

smitcat
Posts: 1273
Joined: Mon Nov 07, 2016 10:51 am

Re: Small Business Owner - how to build retirement wealth

Post by smitcat » Fri May 18, 2018 8:15 am

JBTX wrote:
Fri May 18, 2018 8:07 am
smitcat wrote:
Fri May 18, 2018 6:06 am
JBTX wrote:
Thu May 17, 2018 7:13 pm
smitcat wrote:
Thu May 17, 2018 6:59 pm
JBTX wrote:
Wed May 16, 2018 1:54 am


Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now.

Yes anything could happen with 2 employees. One is my wife. She isn’t going anywhere. Worst case I could probably step in. The other is in operations, thus the desire to create long term incentives.
"Sure there are always risks but owners would have to dramatically change lifestyle if the sold it and lived off the proceeds for 50 years. I don’t think there is any appetite for that right now."

I got to this point reading this post and felt compelled to blurt out that no-one ever see's the decline of a company coming. They play the companies profit growth and then tend to ride it down until it is too late to sell at a decent profit - sometimes the decline comes very quickly with no real notice at all.
Declines can be completely out of the control of a company and/or within limited control that affords very little ability to mitigate the decline.
So I have been at more than one company that I had "a percentage of" which then slid down this track where initially my % times the value of the company at its peak was substantial - then within a year the value was near zero and one time the job went away as well.
Just to remain consistent (so call me wrong if you will but consistent) we have our own companies now and we intend to sell on the top and not rely on the profit remaining strong forever or attempting to time the top (sounds familiar perhaps).
Of course, there are no guarantees. Their biggest risks are major clients decide not to renew at end of contract.

But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000? That would mean you would have to live on $20 to $40, vs $100. I wouldn’t sell. I’m not sure why a Bogle head would sell an established profitable business at a 5 or 10 multiple then turn around and invest it in stocks at a 20-25 multiples.
"But my point is, if your current cash flow = $100, would you sell the business at $500, or at most $1000?"
Depends on the business - we take the closing costs of similar business or a similar size (cash flow) and start from there. For us with what we are doing now the target sale is at a 4X multiple.
"That would mean you would have to live on $20 to $40, vs $100"
With a largely profitable business the owner typically can easily live on the 1/5th to 1/4 number that you have identified. Since typically the taxes will be 33% or larger and savings will be in the area of 40% or more.
"That is a risk I’d take."
Perhaps that is a great idea now and perhaps not, too many variables that no one knows about. One of our large past employers went down unexpectedly when the 'many' banks we worked with did not pay their bills during the too big to fail fiasco. Lost 3,000+ employees with that one and with little notice - unless the business has an unusually high barrier of entry, locked patents and/or are bought there is always a turnover. That and potential regulatory changes, family 'surprises' , competition both domestic and foreign change and turnover are inevitable.
FWIW - the worst potential risks come when the business goes south as it takes your "investment", salary and career with it and if both spouses are in the business it takes both down.
What most do not realize is that with your own business worst case you could quickly end up with quite a large negative worth as opposed to nothing.
I appreciate your perspective, but in this case I respectfully disagree, and more importantly he isn’t paying me to advise him to keep or sell his business. I am tasked with trying to figure out the best retirement plan options for him.
"I am tasked with trying to figure out the best retirement plan options for him." - We utilize our very capable accountant to figure out the best retirement solutions for our situation which include many of the points raised above. I would also suggest he take advantage of his accountant once he has a reasonable list of his goals...... perhaps a family succession plan, licensing, franchising, a leaseback, a partnership or other is in his future.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Fri May 18, 2018 12:49 pm

Different but related question to anybody with any experience on the issue:

I understand whole life is typically a terrible way to accumulate wealth. However, in some ways there may be a benefit in setting up a policy with a guaranteed return to back a Non Qualified future payment to select Keyman employees (vs company holding on to various investments and managing portfolio for 20 years - which will likely be worth more but it isn't guaranteed)

Looking at a couple of 20 year quotes, it appears State Farm had an IRR of around 2% and Federated had an IRR around 4%. 2.0% is a non starter. 4.0% isn't red hot but maybe workable for this particular situation. I came up with IRRs by taking annual payments, ending cash value, and subtracting a term insurance quote from internet to extract the life insurance portion. Obviously this isn't exact but should get you in the ballpark. I used Excel IRR function.

Any words of wisdom when pursuing whole life for a small company? Any providers who are typically better than others?

bsteiner
Posts: 3188
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Small Business Owner - how to build retirement wealth

Post by bsteiner » Tue May 22, 2018 4:31 pm

Notwithstanding the poor expected return from life insurance, it can be easier to administer a nonqualified deferred compensation plan if it's funded with life insurance.

You might want to first look at whether you can accomplish your objective with a qualified plan. You may wish to consult with a good actuarial firm.

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Tue May 22, 2018 5:45 pm

bsteiner wrote:
Tue May 22, 2018 4:31 pm
Notwithstanding the poor expected return from life insurance, it can be easier to administer a nonqualified deferred compensation plan if it's funded with life insurance.

You might want to first look at whether you can accomplish your objective with a qualified plan. You may wish to consult with a good actuarial firm.
Who would I talk to about setting up a non qualified plan, in terms of what you can and can’t do, options to fund it, etc? Is that an attorney? If so, what specialty and how would I find one in DFW area? Or would I need an actuarial firm, and if so again what would I look for?

JBTX
Posts: 3105
Joined: Wed Jul 26, 2017 12:46 pm

Re: Small Business Owner - how to build retirement wealth

Post by JBTX » Tue May 22, 2018 5:52 pm

Spirit Rider wrote:
Wed May 16, 2018 2:52 pm
JBTX wrote:
Wed May 16, 2018 12:56 pm
One more question: it seems like what I am seeing elsewhere is the profit sharing is in addition to the employer match, not instead of it.

https://www.employeefiduciary.com/blog/ ... l-business
That is not correct. There is not even any mention of a match in your link. It is most efficient to replace a safe Harbor employer match with a Safe Harbor employer profit-sharing
What is a gateway minimum contribution?
This is the minimum PS contribution that satisfies the 1/3 or 5% requirement. This why it is better to have no match, because >= 3% PS contribution satisfies the ADP/ACP safe harbor. With a 4% PS Gateway Minimum Contribution (GMC), and $275K compensation the owner could receive a $275K * 12% (limit 4% * 3) = $33K PS contribution. With a 5% PS GMC and $182.5K compensation the owner could receive a $182.5K * 20% (no limit) = $36.5K PS contribution. Both of these would still be subject to cross-testing.
Also in some new comparability scenarios their advisor just sent me they had a new comparability scenario that was in addition to the employer match, not instead of.
I have not generally seen this.
What the guy said was none of the scenarios work great for us because there isn’t enough disparity between owners (owner and wife at low rate of pay) and all the non HCEs which mostly range between $50k and $100k. The results are a significant increase of employer contributions to get increased contribution for owner.
Any attempt to get additional contributions are going to be subject to the specifics of the employee census.
Spirit Rider,

Today I got back a preliminary look at the new comparability profit share scenario with no company match from TPA. As you indicated the non HCE are allocated 5.0%, the 2 non owner HCEs get 3.0% and owner can max $55k and owner wife can put in $30-$40k. I think it is a really interesting scenario, but sadly I suspect the owner will balk at the approx $60k per year profit share to non HCE employees. I guess we shall see.

For a new comparability profit share plan, do you have any vesting period options or does it have to vest immediately?

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Re: Small Business Owner - how to build retirement wealth

Post by LadyGeek » Tue May 22, 2018 8:12 pm

This thread has run its course and is locked. See: Acceptable Topics and Subforum Guidelines
This is an investing and personal finance forum. We also maintain a subforum that allow our members to discuss consumer goods and services and recreational activities. Anything else is considered "Off Topic" and is not acceptable on this forum.
Also: Investing - Help with Personal Investments
This subforum is for all questions about your (or your friend's or family's) actual investments or investment planning.
And: Personal Finance
This subforum is for personal financial issues that don't involve investments.
The OP is asking on behalf of his wife's employer and is for the benefit of this company's employees (vs. the OP or his wife directly). This is outside the scope of this forum's guidelines and is therefore off-topic.

This post is a follow-up to: Small company 401k plans

(This thread is now in the Personal Finance (Not Investing) forum (employee benefits).)

Update: See below.
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Re: Small Business Owner - how to build retirement wealth

Post by LadyGeek » Tue May 22, 2018 10:04 pm

After receiving a PM, the OP has clarified that his DW is a key employee. The decisions made here will impact her directly.

This thread is now unlocked to continue the discussion.
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Re: Small Business Owner - how to build retirement wealth

Post by ad2007 » Wed May 23, 2018 9:33 am

JBTX,

How much are the owner(s) paying him/herself or themselves? If it's an S-corp, wouldn't they net more by keeping earned income at min (the business runs by itself, hands off right?) and take everything else as dividend/distribution - put that into an after-tax acct.

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