Am I Retirement Poor or Am I Irresponsible?
As a business owner, all of us struggle with knowing if we are doing the right thing financially. On the one hand, we know we are building wealth in our business. On the other hand, we’re inundated with messages on the internet that say, “If you don’t have this much in your 401k at this age, you might as well drive off a cliff because you’ll soon be living in state-owned retirement home in dirty PJs!”
OK, that might be an exaggeration, but not entirely!
Either way, doubt creeps in, and we start to question ourselves. Or maybe we’re making great money on paper, but we don’t have the proverbial pot to you know what in.
So, here’s my take after working with small business owners for 20 years. While a lot of ‘rules of thumb’ don’t apply, some still do. Here’s what I think you should be doing at each level:
Meeting Basic Needs
Your basic needs can be calculated as follows: Annual Mortgage / .4. This should be your take home pay (net paycheck / distributions not including taxes). If you don’t have a mortgage, look up what a mortgage WOULD COST on your house if you had one, and run the same number. The .4 factor is a little higher than debt to income ratios you’ll see on the internet, but this is because we are using an AFTER-TAX number, not a pretax number.
If you find that you aren’t taking home enough to meet the Basic Need – you need to focus on getting your business to generate more profit. Don’t worry right now about retirement, as you have a bigger problem in not meeting Basic Need.
Basic Retirement
While we are building wealth in our business, at the same time, we ought to have a ‘rock’ just in case. But how much ‘rock’? While this isn’t perfect, it is a good rule of thumb.
Kiplinger would say that in your 40s, you should have your annual salary X 3; 50s X 6, and 60s X 8. But what’s your salary? Again, use the Basic Needs calculation above, because no matter what your lifestyle is today, if the zombie apocalypse were to happen, chances are you could scale back to this level and be fine. So, take Basic Income X .8 (you reduce it because in retirement most people spend less, not more). This is your starting point. Then multiply by a factor based on your current age.
If you find you are woefully behind, but your Basic Income shows that you are generating plenty of cash (e.g. for example, Basic Income says you need $200,000 but you are really making $400,000) then you need to look at what you can shave in your lifestyle or at a minimum FIX your spending so that each additional dollar goes into retirement. While seeing you are $500k behind might seem daunting as an example, remember that as business owner, between you and, if you are married, your spouse, you can do a lot of damage - $60k - $70k / year into retirement -- without too many bells and whistles. You can make up a lot of ground pretty quickly!
Beyond Basic Retirement
If you are taking care of the Basic Retirement and find that Basic Needs + Basic Retirement is still yielding extra cash, then you are in a great spot! There’s no right answer here on what to do next, so try something like Dave Ramsey’s 50/30/20 (50% income to basic needs, 30% to wants, 20% to savings / investments). If you are not allocated correctly -- I don’t think I’d up my basic needs anymore – however, I would consider fixing my ‘wants’ to 30% and putting the rest into savings. So, if I was at $500,000, and basic needs / retirement was $200,000, I’d fix my ‘wants’ to $150,000 and go savings the rest.
For savings, again you have a few options. You can do more into retirement if you’d like. However, I’d consider some post tax / tax preferred liquid options (like just the good old market or some tax-free bonds) so that when you need it, you don’t have to worry about paying taxes like you would a 401(k) or IRA withdrawal. Also, once I hit a liquidity target (good rule of thumb might be having an equivalent value to your Basic Retirement) look to other asset classes like real estate. It doesn’t all have to be in the market! The market is just the easiest to get in and out of.
Hope this helps! If you want more info on determining if you have a retirement gap or not, check out our free 5-year transition roadmap – even if you don’t think you’ll make a transition within that time frame, because that zombie apocalypse might just happen!