Selling a business, or planning to continue to draw an income from it, in order to fund your retirement doesn’t always go as planned. Although your business may well be an important component of your retirement plan, Yanush Singh, National Business Development Manager at Sanlam, says, “It should not be the only component and your retirement plan should be diversified to include other more reliable and tax efficient ways to save for and fund your retirement.”
The problems with making your business your retirement plan
- Distinguishing between business and personal goodwill: Singh says, “Business goodwill, such as a business’s reputation or location, is different to personal goodwill, which is the intangible value the owner brings to the business by virtue of, for example, expertise, contacts and relationships. If a big chunk of the value of your business is attributable to personal goodwill, which cannot be transferred to a buyer, your business may fetch considerably less than you expect it to.”
- The issue of uncertainty: Singh adds, “External factors beyond our control, such as the COVID-19 pandemic and social unrest, are distressing reminders of the risks associated with doing business in highly uncertain environments. It is often difficult to predict with certainty whether a business will even be in existence at a future date, let alone what it will be worth at that point in time. “Businesses, by their very nature, are relatively high risk. Entrepreneurs accept higher risk because returns are potentially greater than those they can expect from safer investments. So, why would you plan your whole retirement on something that, by definition, is risky?”
- Don’t bank on your children either: “Only about a third of family businesses are successfully transferred to the next generation and less than half of these are transferred from the second to the third generation.
“Generation Z, Millennials and to a lesser extent, Gen Xers, value freedom, which includes the freedom to chop and change jobs. In addition, 4IR (the Fourth Industrial Revolution) is resulting in a more connected, globalised economy with the emergence of new technologies and consequently, new occupations. So, you simply can’t rely on your children to take over your business and, in doing so, help to provide for your retirement. Of course, it’s different if you already have children vested in the business who have expressed a clear desire to take over at some point,” he says.
Providing for retirement
Singh advises that before considering how to create wealth, it is imperative to first protect wealth.
To this end, business assurance arrangements can be entered into to mitigate risk and ensure succession planning in businesses, especially to solve the myriad problems that result from the death or disability of a shareholder or key person. For example, owners who have signed surety for debts of the business are not always aware that on death, assets in their deceased estate may have to be sold to foot the bill, meaning their family may not inherit as planned.
In addition, some owners haven’t considered the fact that the death of a co-shareholder could bankrupt the business as the business becomes immediately liable to settle the deceased shareholder’s credit loan account in full. Moreover, if there is no buy and sell arrangement in place, the deceased shareholder’s spouse will usually inherit their share and take their place in the business.
Singh says, “Your business should not be your retirement plan. But you should be using the income generated from it to save towards retirement! Most owners draw a salary from the business, which is tax deductible as a business expense. However, owners then become liable to pay income tax on these salaries. But, if you invest a portion of your salary in a retirement annuity (RA), these contributions, within limits, are once again tax deductible – and all the growth you earn within the RA fund is also tax-free.”
He concludes, “Retirement annuities are governed by Regulation 28 issued under the Pension Funds Act, which limits the amount of risk, which means RAs can be far less volatile than reinvesting surplus income in your business. RAs are also safe from creditors. It’s a great way to balance out a portfolio and diversify. Of course, the return from reinvesting in your business can be greater, but typically it comes with more risk.
“If you want security and to live with financial confidence, it’s advisable to consult a financial planner with expertise in the areas of business assurance and investments in order to craft a holistic business exit strategy that employs business assurance arrangements in order to mitigate risk, and investments, such as RAs, in order to diversify risk.”
For more information on business assurance and investment solutions for business owners, email@example.com.