Self-employed? Your business is not a retirement plan
You're a successful entrepreneur and business is booming. Though it may be tempting to invest all your profits back into your business, it's wise to put some aside for retirement. Here's why.
The benefits of diversification apply to everyone
Unless carefully managed, the very traits that make you a winning business person - innovation, risk-taking, optimism - can be a recipe for retirement disaster. Everyone knows that the key to long-term investment success is a diversified portfolio.
But my business is doing well
Reinvesting profits into your business may offer excellent returns, and the tax benefits can be very appealing. You've likely convinced yourself that as your golden years approach, you'll be able to sell your business for a hefty amount of capital and ride contentedly into retirement.
But study after study show that only 20% to 25% of privately owned businesses ever get sold. The value of a small business often comes down to the owner's skills, network and customer relationships. In today's rapidly changing world, businesses can become obsolete in the blink of an eye.
Unless you're one step ahead of technology (and employing the very best people), you need to accept the possibility that your business could become less saleable over time. You should therefore have a separate and sound retirement plan.
First things firstNo matter how much money your business is making, one of the cornerstones of financial planning is mitigating risk. For the self-employed, this means making sure you have sufficient life cover and a comprehensive medical scheme option - not to mention the all-important (and extremely affordable) gap cover, which covers the difference between what your medical scheme pays out and the actual cost of care. My husband has a rare blood cancer, so I speak from experience.Next stop? A proper planA well-diversified portfolio might comprise your business, your home and a selection of retirement funds (RAs, pension or provident funds), not to mention other investments such as unit trusts, shares and perhaps some rental property.Diversification lies at the heart of risk management as it lessens your exposure to risk by spreading your capital across a number of different asset classes, countries and sectors, which each operate on their own cycle of peaks and troughs.A privately owned business is regarded as a risky asset (even venture capital), so I'd advise ensuring that you diversify away from your industry sector in your investments to make up the remainder of your portfolio.
It's recommended you don't invest more than 25% of your capital in any single investment or with any fund manager. The same advice would apply to your business, and you need to look for ways to diversify away from a single investment (your business) for later years.Diversification into retirement funds doesn't just make investment sense; it also opens you up to some valuable tax breaks. You can contribute a significant 27.5% of your taxable income to a retirement fund (up to a maximum of R350,000 a year), and there's no tax on the growth of assets within the funds, as well as no capital gains consequences once you start to draw an income from the proceeds.
Be aware of lump-sum taxes if you decide to withdraw an amount before the transfer to a compulsory annuity. It's always wise to get advice so that you can minimise your tax liability.
Whatever you do, don't neglect your business
Realising that your business is not a retirement plan should not stop you from doing everything in your power to increase the probability of a sale. You can do this by embracing innovation and technology, by building a team and a brand that go beyond your personal skill set, and even by investing in business assets that appreciate in value (your business premises), and which can more easily be sold.
If you're in business with someone else, it's also advisable to put a buy-and-sell agreement in place, which would allow you to buy out your partner's heirs should your partner pass away (and vice versa).
The long and the short
Sensible, measured investing doesn't often come easily to born entrepreneurs, so find yourself an experienced and qualified adviser and listen to their advice. There's no denying that diversification might slow the short-term growth of your business, but it will go a long way towards ensuring a more comfortable retirement, and you can regard the possible sale of the business as a bonus.
Hugo is a director of Sterling Private Wealth and Financial Planner of the Year for 2018