Threats to the wealth building of small business owners and how to address them
Small business owners are constantly facing threats to the well-being of their personal and business finances. There are some threats that might be obvious, but there are others that sometimes get overlooked. I discuss three threats to the wealth building of small business owners that often get overlooked and provide solutions on how to address them.
Threat #1: Financial inefficiencies with an uncoordinated plan
Financial planning topics can include cash flow analysis, college funding, insurance, investments, tax, retirement, and estate planning. It might not seem like it, but all these items (and the decisions made on them) within someone’s financial plan are intertwined. As a result, inefficiency in one area can negatively impact other parts of a financial plan. I will illustrate some hypothetical examples that should provide more clarity.
Jane is a sole proprietor who contributes to her SEP-IRA regularly. She is knowledgeable about financial markets but has not taken the time to review the expense ratios (i.e., internal costs) of the investment vehicles used to construct her portfolio. Over the years, Jane continues to invest in securities that have costs too high given her stated objectives, which has lessened some of her investment returns.
Bob owns a small business and has two employees. He is very diligent about saving money each month to his SEP-IRA, child’s education account, and other investments. However, Bob chose to not allocate any of this free cash flow to disability insurance protection. Unfortunately, he injures himself one day and loses the capacity to work for a significant period. With a drastic reduction of income and not having a disability insurance policy, Bob now must start using funds that were meant for longer-term purposes, which limits some of his original financial goals.
Solution: Think about hiring a financial planner that focuses on looking at a small business owner’s entire financial situation and providing solutions on how to efficiently make it all work together.
Threat #2: Inflation
Inflation can be economically defined as a continuing rise in general price levels, which lessens the purchasing power of money. Putting it simply, dollars today will not get a small business owner the same amount in the future. Even further, inflation applies to all types of consumption in our everyday lives. Notice that some types of spending just slowly creep up year after year without a small business owner even really paying attention to it. As a result, these costs can feel like a “hidden” cost. Given that inflation occurs in all areas of spending and financial life, it must be addressed when discussing money goals. I would classify inflation as an eroding factor of wealth since its negative impact seems minor now, but over time, it can significantly lessen wealth building.
Solution: Small business owners should "keep their money in motion," which focuses on growing assets and offsetting the impact of inflation. The growth (investment) vehicles to use depend on an individual’s specific financial situation and goals. Talk with a financial planner who can help implement efficient ways to grow a small business owner’s wealth.
Threat #3: Not understanding tax implications
There are many elements of financial planning that are intertwined, but the one that impacts every one of them is taxation. I note this threat to small business owners to bring some awareness to the importance of clients understanding tax implications across their entire financial plan. Additionally, as presidential administrations and Congress change over the years, there is the potential for tax laws to change as well. As a small business owner accumulates wealth over the next 20-30 years until retirement, many different things can happen over this time. Not only can the tax code (federal and state levels) be complex, but it seems to always change! I noted one hypothetical example below, which will provide clarity on how lack of tax knowledge can lead to a missed opportunity in (or negatively impact) a small business owner’s financial plan.
Larry is a small business owner who has been operating successfully over the past 7 years. However, he insists on doing his own tax returns and has missed many opportunities to reduce tax liability. For example, Larry understands that tax deductions are available for certain business expenses, but many have been missed by him over the years resulting in him paying more tax than is required and lessening his free cash flow, which could have been used to reinvest in his business and/or save towards long-term financial goals.
Solution: With so many tax laws and regulations to follow and them changing constantly as well, it is important to seek help from a tax professional who will help to minimize tax liability. Hire a Certified Public Accountant (CPA) or an Enrolled Agent (EA) who has the tax expertise to provide tax advice and planning to small business owners.