Aging entrepreneurs ponder retirement

By Keith Pangertitsch | January 1, 2010 | Last updated on January 1, 2010
5 min read

I was thinking about transitioning wealth while watching Godfather II the other day. Mafia kingpin Michael Corleone was commenting on his elderly rival Hyman Roth: “He talks to me as a son; as his successor . . . but the old man thinks he’ll live forever.”

Anyone who’s known an ambitious hard working business-owner friend, client, or family member also knows most entrepreneurs believe they can live and work forever. Age does, however, catch up. The coming decade will witness one of the most significant transitions of wealth in Canada as baby boomers reach retirement age. More than $1.3 trillion of wealth created by this country’s entrepreneurs would swap hands as they move into retirement, according to Peter Merrick, author of The Essential Individual Pension Plan Handbook.

The goals and demands of business owners will also evolve from income growth and tax management to retirement income and estate planning. Most entrepreneurs will, for the first time in a long time, experience a period of slowing down as they withdraw from active participation in their businesses. And with any firsts there are bound to be uncertainty, fear, apprehension, and hope.

Advisors who get it right will experience rapid and significant growth in their books of business. Those who fail will, at best, struggle to hang on to the assets they have and miss out on one of the greatest opportunities in decades as business owners actively seek holisitc wealth planners to help them transition into retirement.

The IPP factor

Many Canadian experts think the growth of Individual Pension Plans (IPPs) over the next decade could mirror the meteoric growth of mutual funds in the ’90s, presenting a golden opportunity for advisors servicing high-net -worth professionals and business owners.

Most business owners would prefer the flexibility of a defined benefit plan such as an IPP. If the investments in the plan don’t perform well, they’d have the option of adding tax-deductible assets to the plan to fund the shortfall.

Among other advantages, IPPs offer creditor protection for the owner of the plan even if the person doesn’t file for personal bankruptcy—a benefit the RRSP doesn’t provide. Finally, all the costs associated with an IPP are deductible.

If an entrepreneur has an IPP worth $1,200,000 and is paying 1.5% in management fees, the $18,000 in fees can be added to his or her allowable contribution room in the following year. With maximum RRSP contribution limits of $22,000 in 2010, this added benefit would almost double the allowable contribution level depending on the IPP owner’s situation.

Don’t retire from investing

By the time most entrepreneurs hit retirement, they feel the majority of the hard work has been done and there’s not much you can do to improve their retirement lifestyle—without offering an income strategy to continue to fund shortfalls that were not accomplished pre-retirement. Some business owners may think: “I have either saved enough or I haven’t saved enough and I have already made my important investing decisions before I retired.”

In reality, the decisions that you make at and around retirement are the most important decisions you will make for a client, (see “The retirement rule,” this page).

That means an entrepreneur’s investing career is not even half over the day he or she retires. For a large majority of business owners, the point of maximum wealth is five years plus or minus their retirement date. The impact of a 10% return, whether positive or negative, is far greater when you have $5million after the sale of a business at age 65 than when you have $300,000 at age 40. A 10% return at 40 will net you a $30,000 return in dollar terms versus a $500,000 return at 65.

David Foote, acclaimed author of Boom, Bust & Echo, who spoke to advisors at a Russell conference, noted the average person doesn’t really start saving until in his or her late 40’s or early 50’s. In your 20’s you’re still trying to make ends meets. In your 30’s you’re busy getting married, having kids, and buying homes. In your 40’s you’re still paying down debt, and only after that debt is gone do you really start seriously contributing to your retirement savings.

For entrepreneurs this reality can be specially true. Many are continually investing back into the business where they have greater oversight of the assets and feel they can generate better returns. This means often entrepreneurs have limited or no investable assets in relation to their net worth.

Sequential risk

Compounding the complexity of investing during retirement are the withdrawals clients will need to live off of in retirement. Withdrawals complicate retirement investing because it’s money that leaves the portfolio and doesn’t come back to compound in the portfolio.

When you’re in the accumulation phase, the sequence of returns you achieve doesn’t matter as long as the average compound rate of return over the investing period is the same. When you’re withdrawing money, the sequence of returns can have a dramatic impact on the success of the portfolio. For example: A $1million portfolio with a return of 7.4% every year over a 30-year time horizon could withdraw $50,000 per year and have $1.3million left at the end of the 30 years. However, if we take that same portfolio with the same withdrawal amount and the same average return of 7.4% but with a different sequence of returns, the results are very different.

If we assume a Year-One return of -15%, followed by a 7.4% return in each year from Year 2 to Year 29, and a 29.8% return in Year 30, the portfolio actually runs out of money in Year 27. If we simply flip the returns of Year 1 and Year 30, the client would still have more than $2.4million in assets at the end of 30 years. This of course is called sequential risk, something your clients should be made aware of and something we should all plan for.

Easing into retirement

There’s a tendency in life to continue doing things as we have done them in the past. The reality is things are changing around us and within us. This applies to both entrepreneurs and advisors when it comes to retirement planning.

For most advisors, we take the portfolio we carefully built for clients in their 20’s, 30’s, 40’s, and 50’s and either continue to maintain the same portfolio or tweak the portfolio as they near or reach retirement. The goals of retirees, the duration they spend in retirement, the lifestyle they are leading, and the volatility of the market place demands that we start paying more attention to the special planning and investment needs of our entrepreneur clients.

Our business owner clients will have enough on their plates once they realize they have to transition to retirement. We can help during this transition by assuring them their hard-earned savings will be put to good use in an IPP, by advising them that they shouldn’t retire from investing, and by preparing a retirement-spending strategy for them.

Quite simply, we should be able to tell clients that we can make sure they live comfortably in retirement and that their families will be taken care of in the future. It’s an offer even the most ambitious entrepreneurs can’t refuse.

Keith Pangertitsch