Last week we met a man who said:
“I own a business that’s done really well. In order for me to retire in 15 years, I’ll need to sell it for a decent price. How much will I need to get for it to make retirement possible?”
We proposed four steps for answering his question:
- Picture a typical owner.
We assumed an owner with a business that brings in about $1,000,000 a year in taxable income. He and his wife spend about $300,000 of that on their lifestyle.
- Travel to 2041.
Fifteen years from now, how much money will they need to equal today’s $300,000? Assuming 3% inflation, the answer is a whopping $467,000 (in 2041 dollars).
- Find the source.
Where’s that much money going to come from? Likely the sale of the business.
- Do the math.
How much will the business need to sell for in 15 years to generate $467,000 a year in retirement income? Using the “4% rule,” that number comes out to a cool $11,675,000. Let’s round up to $12 million.
Let me guess. You’re thinking, “Whoa! $12 million is a LOT of money!”
It sure is. So, in part two of our discussion, let’s consider another possibility:
- Check the assumption
That $12 million number comes from assuming the owner will take the proceeds from the sale of his business, invest them (probably conservatively) and draw out an amount big enough to live on and small enough that he doesn’t run out of money before he dies.
We might call that “modern-day, investment-oriented” thinking. Nothing wrong with it, unless you assume it’s the only way.
It’s not.
- Pool the risk
Another retirement income approach is “pooled risk.” It uses the “pooling power” of large numbers of people, the same approach pension plans and insurance companies use. The technical term is actuarial science.
With a risk-pooling approach, a pension plan or insurance company can know the average life expectancy of a large pool of people. They don’t know who will die at any given time. But they can figure with great accuracy about how many will die in any given year.
As a result, they can calculate exactly how much money they need for every dollar being paid out in monthly income benefits. And (most importantly), they can guarantee each member of that pool an income that lasts their entire life.
- Split the proceeds
Back to our hypothetical business owner. With “pooling power,” his options open up.
If he were able to sell his business for $12,000,000 after tax, he’d only have to use about $6,000,000 (at today’s rates) to generate his desired $467,000 a year of income. That $6,000,000 could guarantee a lifetime of income, though the $6,000,000 itself would likely be used up by the end of his life.
What to do with the other $6,000,000? One choice might be to invest it. No one can predict the behavior of the financial markets. But if he earned 7% on that money, it would nearly double every ten years. So, $6,000,000 could become $12,000,000 by age 75, which then becomes $24,000,000 by 85…
Again, let’s tap the brakes a bit – lots of things can interrupt that rosy picture. Among them are taxes, fees and market disruptions.
The point isn’t to predict the future, but to point out another option.
- Start preparing now
To my business-owning friends, my suggestion isn’t to try to pick which option you’ll use 15 years from now.
No, now is the time to prepare.
Prepare your business for the day you may wish to sell.
And prepare yourself and your personal financial architecture so you have the widest set of choices when that day comes.
Don’t waste your time trying to predict the future.
Invest your time preparing for it.
P.S. If you own a business, or you’re just trying to figure out how best to retire, give us a call at Argent Advisors (318-251-5858). We’ll show you possible options and start widening them while there’s still time.
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