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Exit Planning: Here Are 4 Ways to Use a Corporate Retirement Plan to Your Advantage, As Well As 4 Words of Caution On How Not to Mess It Up.

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If you sell your business for as much as you know it is worth, chances are decent that you will have a significant liquidity event. If that is true you will also have a significant tax bill in that year. This is to be expected, but it's not necessarily to be blindly accepted. Here are 4 ways that corporate retirement plans could help you:

 

  1. Before Sale: Salary Increase + Max-Funding Your 401(k) Contributions: This is an effective way of getting cash out of the business in advance, without subjecting yourself to unnecessary income tax. Under the assumption that these are your highest earning years, these deferrals would go into the pre-tax (deductible) side of your 401K plan. This gets more dollars over into your personal wealth without inflating your taxes. Word of Caution: You might worry that such salary adjustments close to an exit might diminish the valuation of your company. We would argue - and industry experts such as The Exit Planning Institute would agree - that these adjustments are simple to explain on your financials, they are practically mandatory to adjust for when you go to recast your financials, and they should be added back to your recasted EBITDA for purposes of finding your real numbers and your real valuation. If you have been paying yourself a salary of $500,000, but a prospective buyer knows that they can replace your employment with only $200,000, $300,000 goes back into the formula as an adjustment on your way to a recasted EBITDA. 

  2. Before Sale: Add Profit Share to the Plan, Tilt in Favor of Owner(s): If your retirement plan is set up to allow for profit sharing, this strategy could increase the amount of funding you can get into your plan on a pretax basis. It is also generally able to fit under a longer vesting schedule, meaning that funds directed to this portion of the retirement plan don't turn over as fast as some of your workforce might turn over so even though it might require additional outlays, there is a decent chance that a lot of the funding here will stay inside the plan for your more longer tenured employees. Folks that leave early with unvested balances simply relinquish those funds to be used for offsetting everyone else's profit share (subject to plan specifics). Word of Caution: Before funding a profit share, yeah please have us or your plan administrator show you projections of how those dollars must be split out. This can vary by employee age, employee class, and compensation amount, among other factors. It's important for you to see this before writing a check to the profit sharing plan.

  3. Before Exit: Pair Defined Contribution Plan with Defined Benefit or Cash Balance Plan: If you have 5 years to go, and if your firm has a relatively low headcount with a significant age difference between you and the rest of your younger workforce, you might look into a defined benefit or cash balance plan. These allow for much higher tax-deferred contributions every year, and if your firm size and demographics fit, it could help supercharge your efforts to get cash out of the business. Word of Caution: These plans are very helpful in the right contexts, and very cumbersome in the wrong ones. Please let us or another firm help you make sure this is right for you before signing the documents to build the plan. Also, these plans must generally be in place for 5 years, so it's best to know how much time you have until exit.

  4. After Sale: Salary Continuation + Continued 401k Deferrals: Assuming your buyer is willing, you can sign a salary continuation agreement to technically continue employment for a predetermined period of time, and you can use the salary they pay you to continue deferring into the retirement plan, again on a pre-tax basis. Why pre-tax? Again, if you have a liquidity event, you might not want to realize all that taxable income in Year One of business exit. Continued employment paired with continued plan deferrals allows you to smooth out the tax ride.  Word of caution: Please make sure that such a salary continuation is reasonable, and seek the advice of your attorney and your accountant with questions. 


We've left out SIMPLE and SEP IRAs, because if you are selling a business of this scale, your deferrals need to be higher to make much of a difference. We have also left out ideas like adding your spouse to the plan, because these are very niche opportunities, not appropriate in every context.


If you want us to look at the feasibility for any of these strategies for your specific company, let us know. We do this on a regular basis.


If this or any of the other posts in this series have been beneficial to you, we would be honored if you share them with others who could benefit as well. 

Thanks for your time, and we look forward to seeing you tomorrow!

 


 

Any opinions are those of Timothy Weddle and not necessarily those of Raymond James. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation.

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