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Wednesday, April 1, 2009

Early Retirement or Freedom?

It can be a long path from deciding to start your own business to the day when you start to make some steady profits. But once that day comes, it can be very empowering. You will find you have less stress at work, you won't worry as much about being late or having to get brownie points from the boss you can't stand.

That doesn't mean the hard decisions are behind you, that is another reason we started this blog. In fact, it is often once you start to see the fruits of your labor that the really tough decisions need to be made.
As tax season starts to roll around, you can be faced with one of those decisions.

Is my Business a path to freedom from a corporate job, or an early retirement vehicle to retire before 50?

You may start and stop several businesses over the years while working full time. But once you start to have a very serious business, you have to decide if this is the idea to give you true freedom or you path to an early retirement. Answering that question can have a huge impact on how you structure your business, especially from a tax standpoint. But, it may also have a bigger impact on how you want to approach your life and what your true ultimate goals will be for your efforts.

Early Retirement

If you choose to use your business income as a retiement vehicle, you have some really good options. The Simplified Employee Pension Individual Retirement Account (SEP IRA Wikipedia) is a great option for you. Unlike your company 401k that caps our around $16,000, the SEP IRA allows you to contribute 25% of your business income (up to $46,000 in 2008) into a retirement account.

Match that up with any retirement plan in the corporate world and it will be very hard to beat. I see this alone as reason enough to start your own business, especially in the face of this economy where large companies like Motorola and FedEx are stopping 401k contributions.

However, just like normal IRA's you won't be able to access that money until 59 1/2. If your goal is to eventually leave your job to work for yourself full time, we would highly advise you to make sure you have a significant amount of emergency savings (up to 2 years expenses) available in case you run into hard times like we are experiencing now. That may make the SEP IRA not the right choice for you or your company.

Path to Freedom

If you want to build up a cash reserve before heading out on your own, then you may want to have access to your business income before the age of 60. Especially if you think it will require an investment to grow your business to the point where it can support you and your family.

In this case you can hedge your bets by placing some business income into taxable savings accounts like CD's, index funds or bonds to grow the money while you wait to build up enough to make your move. You may not be able to take advantage of all of the tax benefits available to you, but you can give yourself the flexibility to delay this decision until you have more confidence in your business or in your ultimate goals for your life.

It is very important for you to discuss these options with your accountant and in some cases your lawyer. We are big fans of Legal and Tax advice and paying well for good advice. But paying for good advice is not the end of the hard work. It is also very important for you to take control of your business direction. It is very likely that your accountant will advise you to start an SEP IRA because on paper it is a great tax benefit. However, if this benefit does not help you reach your ultimate goal, then you need to be honest with your advisers and they can help you meet your needs as best they can.

To date, none of us have chosen to start SEP IRAs. We have instead chosen to reinvest the income or place it into taxable accounts that give us flexibility to make future decisions. This is another reason why I am such a fan of Canada's version of the 401k, the Registered Retirement Savings Plan (that is for another blog). Despite not starting an SEP IRA, the business income has allowed us to maximize our corporate 401ks and other options available to us.

We would love to hear from anyone who has faced this decision. As you start your path to being a Corporatepreneur, you will learn that no one can tell you the exact right way to run your business or make the best decisions for you. You need to gather as much info as you can about your options and find out which is the right pat for you.


1 Comment:

Jason Cohen said...

Another word of advice: Make sure you have complete control over your investments inside the SEP-IRA.

For example, if you had put all your IRA money in CDs, you'd be laughing now. But if your 401k plan *required* you to put everything into a family of mutual funds (which most do), you're hurting.

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