When it comes to saving for retirement, self-employment presents different challenges. Salaried employees should save for retirement no matter what, but those who own a business have to decide what will deliver the biggest financial benefit. Sometimes, saving for retirement is more lucrative; other times, it’s better to reinvest in the business.
Why Saving for Retirement is Better
Conventional wisdom says this is often the right choice, and there are a few clear reasons why.
First, you get more tax benefits. Everyone, small business owners, in particular, benefit from shielding income from taxes. Fortunately for those who are self-employed, there are generous tax benefits to contributing to an IRA or other retirement plan. Making the maximum contribution allowed can potentially save tens of thousands of dollars in income taxes while also increasing your assets.
Saving for retirement also gives you a chance to diversify. Not all small businesses are successful, and even those that are face a lot of bumps in the road. Sudden changes that you have no control over can drastically affect your business, for example, a lawsuit, changes in regulatory oversight, or a new competitor. Losing the business is hard enough, but if you have nothing to fall back on, the loss hits even harder. By making regular contributions to a retirement plan, you could have diversification in your investments so you’re not completely starting over.
If all of your money is invested in the business, you only have a single major asset to build on. On the other hand, if you fully fund a retirement plan, you can work to grow your business while your investments also grow over time. One of the best things you can do is put your money into something completely independent of the performance of your business. This is particularly true if your business doesn’t have much resale value.
Some businesses have a lot of resale value but, in most cases, small business owners themselves are essentially the business. This means that the business likely ends when the owner retires and will no longer produce any capital. A retirement plan is the best and most logical way to counter this to make sure you potentially have a steady income into retirement.
Why Investing in Your Business is Better
Of course, there are equally valid reasons to put your money back into your business.
For starters, reinvesting is done to improve the business and increase income. As the business grows, so does the profit, which increases your income and ultimately allows you to save for retirement.
If you’re just getting started, investing in the business before retirement is often necessary to get things off the ground. At this point, retirement savings are seen as unimportant since you’re still working hard to get the business to take off and investing every penny into getting it there.
Reinvesting in your business also lowers your tax liability. If you buy equipment, for example, you can write it off when filing your taxes, whether in the current year or spread out over several years.
Some business owners build a business they plan to sell and use the profit to fund their retirement. In this case, reinvesting in the business is directly related to how much you’ll profit from the sale. This ultimately boils down to the type of business you have and whether or not it is profitable enough to attract a buyer.
Another thing to think about is that a lot of small business owners continue working past retirement age. They don’t have a boss, they make their own schedule, and, in a lot of cases, they love what they do. Reinvesting in the business from day one can build something that’s truly profitable and sustain the owner for a long time, even into retirement.
Doing Both is Ideal
There are a lot of factors involved in making the decision as to whether to invest in your business or put money into a retirement fund. Honestly, doing both can be a great solution. This is the best way to maximize your profits and make sure there’s something there for you when it’s time to retire or sell the business.
Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Expressions of opinion are as of this date and are subject to change without notice.
While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.