How I manage my own finances as a small business owner: Part 2
My firm, Lasting Wealth Principles, provides financial and tax planning services to small business owners to help them coordinate business and personal finances, which will optimize and protect their wealth. As a small business owner myself, I understand the unique challenges and needs of small business owners. Since my goal is to help small business owners minimize their tax liability, invest their money for retirement, and take care of their family's financial future, I wanted to write a blog series about how I accomplish these financial goals in my own life. I explained wealth protection strategies in Part 1 of this blog series. I discuss wealth building strategies in Part 2 of this blog series. Note that these strategies are for my own financial situation and goals and should not be taken as specific advice for other small business owners. For privacy purposes, specific details about my own financial plan are not included and the lists are not exhaustive. My purpose is to just give other small business owners a general idea of some things I do in my own financial life.
Wealth building strategies
Retirement plan: Simplified Employee Pension Plan (SEP) IRA
Small business owners must be proactive in creating their own retirement savings (and not just rely on the potential sale of their business in the future). There are retirement plan options available to small business owners that provide tax advantages (i.e., tax-deferred savings) and flexibility. For my own business, I chose a SEP-IRA, which is a retirement plan option that is advantageous to small business owners with a few or no employees. With a SEP-IRA, there is no annual contribution requirement so it provides me flexibility as I can decide on how much to contribute based on the performance of my business in a specific year. The SEP-IRA annual contribution limit is based on compensation (limit is lesser of 25% of compensation or $69,000 for 2024) so this provides me with an opportunity to save more for retirement when compared to annual contribution limits of other IRA options such as a traditional IRA ($7,000 for 2024) or Roth IRA ($7,000 for 2024). Additionally, the low start-up cost, simplicity of setup, and low operating costs going forward were other reasons why I chose a SEP-IRA.
My investment philosophy leans more towards a passive approach, which focuses on simplicity and keeping investment costs low. I used this passive approach when constructing the investment portfolio within my SEP-IRA.
Education: 529 College Savings Plan
For small business owners who have children, saving for their college education is generally a financial goal. Preparing for my two sons’ cost of college (tuition and fees, room and board, books, transportation, and other applicable expenses) is a goal of mine. Given the rising costs of college education, I understand that a four-year degree is a sizable amount to prepare for, which is why I started saving for my sons early. Having college savings in place for them helps safeguard the financial future of my family (e.g., no student loan debt). No student loan debt frees up cash flow to be used for other wealth building opportunities.
There are several ways to save for college costs. The strategy I chose is investing in a 529 College Savings Plan due to its tax benefits and flexibility to change the beneficiary. I note that the specific 529 plan that I chose has investment options available that are low-cost.
Tax benefits: investments grow tax-free, and withdrawals used for qualified education expenses are tax-free.
Beneficiary changes: a beneficiary can be changed to another family member with no tax consequences if the original beneficiary does not need the funds. An example could be an older sibling not needing the funds after receiving a scholarship so then the funds are available for the younger sibling to use instead.
Homeownership: Building equity
Like any other financial commitment, there are pros and cons of homeownership. The primary drawback of homeownership is the amount of annual carrying costs, which include property taxes, maintenance, home improvements, utilities, and insurance. However, if these costs are managed properly, homeownership provides long-term, financial benefits that include home value appreciation and home equity. There are no guarantees that the value of a home will increase, but if a homeowner is in their home long enough, then there is a strong likelihood that the home will appreciate in value. If a homeowner has a mortgage, then home equity grows each time a mortgage payment is made since a portion of the payment is going to lower the balance of the loan.
I have been a homeowner for almost twenty years and have faced a major downturn in the real estate market at one point and dealt with annual carrying costs over this time, but homeownership has still been beneficial to me as it has been another way to build equity.