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Should I Stay or Should I Go? The Financial Planning Process Will Tell If You’re Ready to Exit

Is Your Business Income Enough to Provide for Retirement?

Many business owners thinking about selling their businesses struggle with one major uncertainty: will the proceeds be enough to walk away from their business? . Experts say you need at least 80% of your annual, pre-retirement income to comfortably live as a retiree, but depending on your lifestyle goals, that number can look very different. In order to understand how much you will need to sell your business, you need to go through the financial planning process.

Let’s look at this sort of situation through the eyes of George and Gracie as they navigate the financial planning process with a professional.

The Scene: Meet George and Gracie

It all started when George asked, “But, how do we know our money will last?” Gracie, as usual, got that uncomfortable feeling in the pit of her stomach whenever George started asking her those “innocent” questions about their savings and retirement.

George, a professor at a local college, usually feigned disinterest about money. Gracie was the entrepreneur and MBA, but every once in a while he would surprise her.

The Existing Retirement Plan

Gracie founded her marketing consulting firm 20 years ago, serving an active niche in the media industry. With consultants working nationwide out of regional offices, the firm had talented senior consultants, as well as a strong management team. A number of financial and strategic buyers had expressed strong interest in acquiring her business.

Everything was on track for a successful transaction, and the proceeds were right in line with the expectations she had set several years ago. Based on the most recent calculations, Gracie would net approximately $5 million from the sale.

Gracie’s personal compensation over the last three years averaged around $400,000 per year. Gracie and George were diligent savers and had set aside approximately $1.5 million in retirement savings, in addition to investing in her firm. She was ready to retire and spend more time with family and volunteer activities, and George was ready to scale back his work as well.

How did they know there was enough money for everything they wanted to do in retirement? None of her advisors went into much detail about retirement finances. No one had asked what she and George wanted to do with the money.

“Well, George, it’s a pretty big nest egg,” she remembered saying. “We should have plenty in the bank, and we’ll invest some in bonds and maybe some safe stocks. We’ll pretty much live off the interest and shouldn’t have to dip into principal.”

“I see,” George had replied. “But I heard bank rates are near zero.” Gracie started doing some quick mental math. Something wasn’t quite right, and she knew she needed some advice.

Is it Time to Sell the Business?

Gracie sat down with Thornton Gildersleeve, the advisor working with her on the sale of her business. Gracie expressed her concerns about the sale in light of her conversation with George.

Thornton listened carefully, then shared some things for Gracie to consider. She could certainly back out of the transition and continue to run her firm and enjoy the business income. “Gracie,” Thornton asked, “Will your heart really be in it for a few more years if you decide to stay on? And, if you don’t sell now, when?”

Gracie had invested a great deal of energy and effort over the last several years getting the business in tip-top shape. There was no certainty about future valuations. If the company’s sales or profitability, or the general economy faltered in any way, the value of the company could go down dramatically. “These are big risks,” he explained.

Thornton continued, “Gracie, how would you like to have someone walk you and George through a detailed financial plan? A model, if you will, of your personal cash flow and balance sheet for the rest of your lives?” It was time to start the financial planning process.

Taking the First Step in the Financial Planning Process

Gracie’s first meeting with Jack Benny, a Certified Financial Planner Professional, went well. Gracie shared the story of her firm with Jack, from start up, through rapid growth, to preparing for sale. She also talked about her family and plans for retirement. “What am I missing?” she asked. “What’s wrong with putting the money in the bank and living off the interest?”

Jack nodded, understanding where Gracie was coming from. “The idea of keeping your money safe and living off the interest is intuitive, and we will focus on safety,” he began, already seeing that financial safety was important to Gracie.

“However,” continued Jack, “George is right; bank CDs pay next to nothing, and low risk bonds, like US Treasury bonds, also pay very little. Bonds also have interest rate risk, meaning that if market interest rates increase, the value of bond investments fall. What’s more, CD and bond yields don’t account for inflation or taxes. So, in a practical sense, you actually lose money.”

“This doesn’t mean you can’t retire – far from it. Many of our clients have felt this concern. What they have found helpful is a financial plan, which details all of their goals and crafts an investment strategy that gives them the best chance for success. They gain a lot of confidence from this.”

“This sounds helpful,” Gracie agreed, “How does it work?”

“First, we establish and define what you need to get from our working together,” Jack replied. “We’ll gather information about your current situation and review your goals and plans. Next, we’ll analyze this data and craft recommendations and alternatives for you to consider. Then, we help you implement the plan,” Jack continued, “A plan isn’t any good just sitting on the shelf. And, just as importantly, we will help you monitor the plan over time.”

“I’m not sure how this specifically answers the question,” Gracie replied. “How do we know if we have enough money to retire, and how do we know it will last?”

“Let’s reflect back on the way you were originally thinking about generating retirement income,” Jack answered. “It’s the same way most people think: ‘Let’s live off the interest and dividends and not dip into principal.’ Right? If that amount covers your living expenses, you may be ok. Unfortunately, for many people, it doesn’t. This way of thinking also overlooks the complexity in people’s lives.

“A financial plan is kind of like a 40-plus year budget,” Jack explained. “We carefully review all of your planned expenditures for the rest of your lives, not just your day-to-day living expenses. While things may change, it’s helpful to quantify in dollar terms what everything will cost. We’ll work on optimizing your tax situation, benefits such as Social Security, and insurance.”

Jack was trying to convey an important reality to Gracie and George about investment risk. Simply living off of interest wouldn’t do for most couples. In terms of investments, the reality is that to achieve their financial goals, most people need to accept more investment risk than they originally think. That said, Jack assured the couple that he would spend a lot of time with them to really understand how much risk they would be comfortable taking. Then, he would use that limited risk “budget” to achieve the best long-term returns possible.

“I say ‘returns,’ not ‘income,’” said Jack, “because most professional investment managers focus on the total return of an investment portfolio, which includes investment gains as well as dividends and interest. As a result, when the investment markets are flat or down, we do ‘dip into principal.’ When the markets do well, we save more and add to the principal.”

“How do you know this works?” Gracie interjected.

“The simple answer is that there are no guarantees – we’re not absolutely certain,” Jack said. “We strive for a high certainty, an 85-90% chance of a successful outcome. We do this by running the plan through a thousand or so market scenarios and adjust the plan and investment strategy accordingly. We also review the plan every year or two, so if we need to change something, we will.”

Gracie and George asked Jack to prepare a comprehensive retirement plan, focusing on a sustainable income-stream based on their goals and resources.

The Current Retirement Outlook

In terms of resources, Gracie and George expected investable assets to include $5 million from the sale of Gracie’s company, and the $1.5 million they have in retirement savings. Together, they expect about $50,000 in annual social security benefit. Jack determined that they had a moderate tolerance towards risk.

They owned two homes with a total value of approximately $1.4 million. Both 66 years old in excellent health, Gracie and George owned several life insurance policies with several million dollars in death benefits, and approximately $110,000 in cash value.

Setting a Retirement Goal

Gracie and George expected to need between $240,000 and $270,000 annually to support their lifestyle. They would like to substantially support college educations for their five grandchildren, beginning in two years. They felt they had provided very well for their own children growing up, so they didn’t feel the need to make substantial gifts to them. Nonetheless, they did want to understand the impact of a plan that included leaving about $1 million to their children and to charity. They also wanted to learn about paying for long-term care.

The Second Retirement Planning Meeting

It took Gracie and George a week or so to put together the information that Jack had requested as part of the financial planning process. They also had some time to talk about their goals to build retirement for their family.

Now, Gracie and George were meeting with Jack for a second time to further analyze their plan.

After exchanging pleasantries, Jack reviewed the goals of the meeting as well as the scope of the overall engagement.

Jack went on: “We are confident that you and George can meet your priority goals. We also think that the investment strategy we’ll discuss will feel right to you in terms of risk. We’ll talk about alternatives in some areas that were secondary goals for you. We’ve taken into consideration everything you mentioned wanting in the plan, and we hope to help you make decisions you’ll feel good about.”

Here’s what Jack concluded: In terms of annual spending for lifestyle, Gracie and George would start with $250,000. About $50,000 would come from Social Security, and the remainder would be withdrawn annually from their investment portfolio. In addition, Jack’s firm earmarked about $250,000 for their grandchildren’s education. After considering a thousand or so market scenarios, Jack was highly confident that there would be an inheritance of nearly $1 million at the end of the plan.

“Before we go on,” Jack asked, “How does this sound so far?”

“It seems like we’re cutting too much at the beginning,” George replied, “We want to be able to enjoy some things while we’re still young.”

“All right,” said Jack, after George explained their desire to maintain or even increase their travel in the next few years. “The $250,000 spending scenario is based on level spending—adjusted for inflation—for the remainder of your retirement. Some people anticipate spending more money earlier in retirement and a little less later on. We can create a scenario like that for you to consider.”

“Can you help us understand how we get $200,000 per year when CD rates are so low?” Gracie asked.

Jack replied: “We anticipate an investment portfolio of about $5.25 million after setting aside $250,000 for the grandchildren’s education. So, $200,000 represents a bit less than a 4% withdrawal rate, which is about average. Since managing a portfolio for total return creates the best chance of meeting long-term goals, and long-term returns are in the 5-7% range, we believe that withdrawing this amount will be safe.”

“Why did you set aside the money for the college funds?” George asked.

“For a couple of reasons, George.” Jack answered. “Setting aside money is a good way to make sure you can afford a major goal. Additionally, it makes sense to meet our goals in a tax efficient manner. And in this case, we recommend tax-advantaged college savings plans, such as 529-plans.We’ve set aside about $50,000 per child for college, an amount which will nearly cover one year of expenses. 529-plans are very flexible and allow you to maintain control over who gets to use the money and when. This is important if some children receive scholarships or others choose not to go to college.”

“What about insurance?” Gracie inquired.

“We’ll follow up on insurance in detail,” Jack continued. “According to our life insurance needs analysis, no one is dependent on your or George’s income in the future. So, neither of you need life insurance any longer. However, we will consider exchanging some of your policies that have cash value into policies with long-term care benefits.”

Coming to an Agreement on Retirement

“This is starting to make sense,” Gracie said. “You’ve laid out a plan providing a good amount of retirement income for us, considering a bit more spending money in the early years, and setting aside a base amount of money for our grandchildren’s education. You’re not investing all our money in bank CDs, but rather an investment portfolio that aligns with our risk tolerance.”

“That’s right,” Jack agreed. “We’ll review the plan annually to ensure that both investment returns and spending are on track. If they aren’t, we’ll decide what to adjust.”

A New Financial Plan, A More Confident Future

Gracie and George felt more confident in their retirement plan and that they wouldn’t need to live off of near 0% bank CD yields. Jack would work with them to restructure their insurance, help with estate planning and look for ways to minimize taxes.

But did they sell their business? Perhaps.

The issues surrounding retirement income were not the only issues Gracie and George needed to consider. Gracie and George would also have to consider business transition planning – they do have a daughter, after all, lovingly named “Baby Snooks.” They may have also considered selling to an employee stock ownership plan, or ESOP. All of these issues combined make up their full financial planning process.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Goal Based Investing – Planning for Key Life Events and Roadmap to Selling a Business or Taking on Outside Investors. This is an updated version of an article originally published on March 27, 2015.]

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About Edward W. "Tad" Gray III

Tad Gray, CFP®, CIMA® is a Relationship Manager of Financial Solutions Advisory group, an independent fee-only wealth management firm. People work with Tad are busy professionals whose primary financial concern is staying on track toward the promises they’ve made. They trust, that together, they’ll make financial decisions that will ensure they keep these promises. Prior to becoming…

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