Sponsored by TD Wealth
Kenneth Thompson, SVP, TD Wealth
TD Wealth Private Client Group has been working with successful business owners for more than 150 years and understands the needs of individual business owners across the business cycle from inception to succession.
How can business owners ensure their financial future and the growth of their business? We spoke with Kenneth Thompson, SVP at TD Wealth, about how he and his teams work with their client’s through careful planning to develop a financial roadmap to the future. Thompson noted that business owners have different concerns for each stage of the journey, especially when approaching retirement.
What is one of the biggest concerns for business owners when planning for their financial future?
The question is loaded with so many rich things that we can address. Because it really is a point-in-time-question. What I mean by that is if we think about the journey of a business and then the journey of an individual through their life, at each point they're going to have different concerns that become more pressing at different points throughout the journey.
We know this from talking to business owners on a daily basis and assisting them with their planning. This was also highlighted in our recent survey. According to the TD Wealth’s Business Owner Retirement Readiness survey of over 1,000 high net worth individuals who own a business, 95 percent of those surveyed are confident (very or somewhat) that their financial plans will be able to generate the income needed during retirement. However, as business owners approach retirement age, confidence dwindles.
When we talk about confidence level of high net worth business owners regarding retirement, the younger you are the more confident you are and that is because in a lot of ways there's a lot of other things that you're concerned about in the early part of a business development that have nothing to do with retirement. What tends to happen as individuals, we don’t think about the things that we don't have to worry about yet, and we have higher confidence with them because they're not immediately pressing.
As business owners got closer to retirement their confidence level went down and that was a combination of a couple of things. One is that time has shrunk. All of a sudden you don't have as much time, so you have to start thinking about retirement. Also, you learn, over your lifespan or the life stages of the business, what works and what doesn't work, and you learn what you thought to be true didn't always happen the way you thought it would. You have external factors that you are coming up against that you weren't aware of, but as you go longer into that business cycle you start to become very aware of it given that your business, at this point, has been through a couple of cycles.
When planning for the financial future, the biggest concern a business owner has is that there are so many things to think about in their day-to-day running of the business. It can be a little overwhelming when it comes to things outside the business. Let’s take a recent example I heard of a business owner that runs a local, "green" dry cleaner. The business failed on the first attempt, but now it's a very successful endeavor with multiple locations. For example, when that business made $9,000 in their first year, the concern was not retirement, the concern was, "Geez, how do I make this business profitable."
Taking into consideration that stage of the business cycle, the ultimate concern is not having enough. Not having enough today in the current stage of my business, enough to invest in the business, enough to make a profit in order to live, enough in the later stages for when I want to retire and be able to leave and transition the business to a new owner.
What we've done at TD Wealth is to bring in the planning aspects, meaning understanding each of our client’s goals both short and long term and the purpose of those goals. This helps our clients to start to articulate what they are actually thinking about and allow them to prioritize the things that are most important. It is only after we've gone through the planning process that that we can determine what's most important for that individual. It’s individualistic. It's dependent on the stage that they're in, both as an individual and as a business, and it also depends on the goals and aspirations they have, both as individuals and as a business.
When should I start developing a business succession plan?
Business owners should make it a priority and should focus on it as soon as they can. Many business owners tend to think about this way too late. They tend to think about a succession plan when the business is well developed, well on its way, and at its later stage. The problem there is that you may have already limited the type of succession considerations. For instance, if I want this to be a family operation that goes on for generations, I have to articulate that strategy with my family early on. I need to make sure that my family members have the same aspirations for the business so that they can be considered in the succession plan. If I wait too long, and I find that nobody in my family is really interested in keeping the family business going, all of a sudden that strategy has been taken off the table. Now, I have to think about, how do I monetize this business? Can I sell it or is it sellable?
In other words, I put my passion into the business and that is why it succeeded, but the next individual may not have the same passion. That gets into business valuation services. At TD Wealth, what we've done is two things. We have discussed the planning to make sure that we can provide an owner the tools to identify their goals along the different stages of the business cycle. What we have done recently is to offer business valuation services at TD Bank to help the business owner determine the value of that business at each point in time across the business cycle.
By starting early, you get to establish what I'll call the starting and foundation points. For example, if I say, "Hey, at this milestone, this is what my business should be worth. I have a goal to make it worth X when I retire at age 50 or 60." Essentially you have "stage checks." You're going to have these points where you're going to see if you hit that milestone? And if not, what adjustments do we have to make in order to get the business ready for that point of succession?
What should businesses be thinking about from a tax perspective, given that an election year is approaching?
When thinking about this question, I initially jumped right to the current administration and the year-over-year changes and what that could mean but as I thought about it more, we should start with the overall tax landscape and the tax implications affecting the business.
One of the first things that we want to do before addressing the question is to make sure that we understand the tax impact on both how we are running our business and our personal life today. Say we are already maximizing tax-sheltering within the business, are we providing for our employees with a 401(k)s or 403(b) plan or some other type of retirement solution? Do we have our own retirement plan? Will there be an "ease up" or some other sort of sheltering activity in order to maximize tax deferral?
The next thing is placement. Are your assets being managed in securities that are most tax-aware? An example would be fixed-income instruments, like bonds, as they generate interest on a regular basis that is taxable. If you're going to own fixed income instruments, it is better to own those securities in a retirement account where it's tax-sheltered versus owning it in a non-retirement account where you're going to be taxed on the interest you receive. If you have a portion of your portfolio invested in fixed income instruments, you should also consider if you would benefit from having it in municipal securities or other tax-exempt securities so that you could shelter that income from taxation.
A lot of small-business owners are often intertwined with their businesses; meaning, their personal wealth and business wealth are one and the same. So, where your assets are being held makes a lot of sense. It is something that you really want to check at the end of the year. After you have validated that you're taking advantage of all the things that you can from a tax perspective, do you also have the right legal structure for your entity in order to maximize the tax benefits that are allowed under the current tax code? After you've done that, then we look into the future.
You have to be concerned about two things with upcoming elections. The first is the local impact, meaning how those local elections could have influences on your business; and what does that mean, in the short term to your business model? The second is from a national perspective. The current administration is more favorable towards small-business owners than previous administrations. But that cycles. So, in a full lifecycle of a business, you're going to go into both favorable administrations and unfavorable administrations.
Therefore, working with an advisor who understands what the tax changes could be will help you to compartmentalize some of these concerns and address them in their right order. When you sell a business, there are lots of concerns about succession and other things that you may want to set up. Whereas earlier in the business cycle, it is often about tax avoidance. You can’t always be aware of every implication. You may think you are aware and all of a sudden, they change X, Y, and Z in the tax codes for small businesses. You may not be able to avoid it and will have to be adaptive and work with your advisors to reposition your portfolio in order to benefit from the current environment.
How can TD Wealth assist in planning for my retirement?
At the end of the day there are five considerations that determine whether the client is successful. The first is understanding their goals for retirement. Retirement is now a stage in which a lot of business owners have chosen a second act. Meaning, I may do this business today, but in retirement maybe I teach somebody about my business or maybe I'm a consultant. So, understanding that transitional stage with the business owner of what they want to do next is the most important thing we can do.
The most important thing an individual business owner can do is to develop goals-based financial plans for the early, middle and late stages of the business cycle and to keep them updated.
The second thing is to consider the time frame for succession and match up the timeframe for retirement with their plan. When do we want certain things to happen? When do I want to retire? When do I want to start the second business? When do I want to transition the business or provide a legacy for the future? And again, I think that time frame is so important because sometimes we have a long term wish with a short-term time frame and those don't always match.
The third consideration is risk analysis of today versus tomorrow. There are three types of risk that we really want to focus on with a client. The first is the risk of principal. In retirement, you won't have an income stream anymore so how are you going to replace that income stream? Can you afford to have principal at risk and what amount of principal can be at risk?
The second risk is the risk of inflation. The reality is that the money has to last over time. So, we have to look at how long we want that money to last and what is the expectation of inflation during that period of time so that we can keep up with the cost of living.
The third type of risk is volatility risk. In retirement you don't want to see the value of your assets go up and down as frequently as they did when you were younger, again, understanding that and making sure your portfolio is adjusted for lower volatility is normally what we advise. I say normally because there are business owners who are in their second act where retirement is nothing but a stage, another chapter in a book that they're writing. They may be as aggressive as they were when they were much younger, but only with a portion of their assets. They don't necessarily want to work until they're 95.
The fourth consideration that's important with us is, and this goes back to planning, is cash flow. What is your income and your ability to continue to add to it in retirement. Again, this is a stage. It used to be, I retire, and I have my pension. Now it's I retire, I may continue to work, which continues a stream of income continuing the stream of investable assets to grow my portfolio. Planning takes all these things into account and puts them together to create the client’s retirement story.
The fifth consideration is the potential return on the portfolio. How are their assets working for them? This includes the value of their business if they were to sell it, their investment portfolio and even their compensation growth expectations (i.e., the return on "Human Assets"). I placed this consideration last because regardless of return on assets, it cannot make up for mistakes of bad decisions in the first four.
As a business owner, if I'm interested in sustainable investing, what's the best way to go about it?
If you look back 15 years, we talked about socially responsible investing in the context of values-based investing, which meant I don't want to own sin stocks: tobacco and alcohol, to name a few. Very frequently that lowered the return potential of a portfolio because we were basically putting filters on a portfolio to exclude certain industries. As we moved through time, the focus is now on ESG, or Environmental, Social, and Governance - that's your sustainable investing.
In addition to the planning process, TD Wealth works with clients to understand their preferences — what is important to them and their lifestyle. Socially conscious or sustainable investing takes into consideration the environmental impact of investing. In this regard, clients are concerned about their portfolios impact on the environment.
A great example of this is when a well-known international brand became one of the first companies to actually successfully sell water. Because it was a commodity, no one was ever going to pay for water, right? Fast-forward to today and we willingly pay for water. We have bottled water all over the world. So, this brand thought about the actual impact they were having and could have on the environment. They decided to thin out the construction of the bottle in order not to use as much plastic. Now they are taking it one step further and are looking at biodegradable solutions for those bottles. That is a great example of a positive environmental impact.
What socially conscious investing is doing today, is looking at companies that are aware social issues like diversity and inclusion, governance issues and how, again, companies are being run for the benefit of their employees, and the wider community. It's becoming more prevalent. Today, we have access to about 600 different fund managers. Some of them are specifically focused on sustainable investing. I truly believe that in the next 15 plus years, ESG is going to be embedded in how companies do business. The companies that focus on this are probably going to get a premium. So where in the past, socially responsible investing was something that was values based and could potentially lower the return on your portfolio - today, sustainable investing actually, gets a premium and can increase the return on your investment portfolio.