How to protect your personal finances when starting a business

There were nearly 5.4 million new business apps in the United States last year, according to an analysis of census data by the Economic Innovation Group, the highest number of startups launched in a single year ever. checked in. And that’s on top of a banner year in 2020.
But not all startups are the next Apple or Netflix. While there is potential for great long-term benefits for entrepreneurship, there are also plenty of financial hurdles to jump through along the way. For starters, about a third of small businesses fail within the first two years, according to the Small Business Administration.

“In the world of entrepreneurship, many seek and few get chosen,” said Clark Kendall, president and CEO of wealth management firm Kendall Capital in Baltimore, Maryland. “You have to go there with your eyes wide open to the risks.”

When it comes to your personal finances, the risks of starting a business can include losing some or all of your savings, income, and possibly your assets, if you’re not careful. . There is also the risk of opportunity.

“You could have worked for someone else and received a regular salary instead of risking starting a new business with unknown earnings and future earnings,” Kendall said.

That said, for successful companies, there is also a lot of upside potential. But no matter how focused they are on the business, it’s important for small business owners to think about their personal finances as well. If you’re ready to join the growing ranks of the self-employed, take the following steps to protect your finances:

1. Prepare for a financial sacrifice…in the beginning

Most businesses don’t make any money at all for the first few months (or longer). If this is your full-time goal, it means you probably won’t be making money for a while. If possible, start increasing your personal savings before starting the business, so you have the resources to cover your bills and living expenses during this time.

Chad Parks, founder and CEO of Ubiquity Retirement + Savings, recommends planning at least six to nine months of expenses if you’re starting a business and have no other income to fall back on. Think of this money as untouchable and only meant to be used within the company.

“When you start a business, there’s always a sacrifice up front. It’s on the financial side, as well as time to build momentum,” said Nick Foulks, director of communications strategy and engagement. client at Great Waters Financial.

Once the business starts generating revenue, you’ll also want to start setting aside cash reserves – up to a year of business expenses – so you can separate your own financial responsibilities from those of the business. .

“A lot of entrepreneurs make the mistake of treating their business like a bank account and only withdrawing money when they need it,” said Robert Gilliland, managing director and senior wealth advisor at Concenture. WealthManagement.

2. Get on the payroll

As soon as you start drawing a paycheck from the company, you’ll also want to start putting money into a retirement account. Even if you’re not able to contribute much, the earlier you get into the habit of saving for retirement, the better.

“We’re creatures of habit, so you want to get used to paying yourself with a paycheck,” said Marcus Blanchard, certified financial planner and founder of Focal Point Financial Planning. “There are many retirement savings options for entrepreneurs.”

The savings vehicle you use will depend on your financial situation and the type of business you have, but here is an overview of three checking accounts:

A Traditional Individual Retirement Account (IRA) or a Roth IRA

If you’re setting aside $500 a month or less, an IRA may be the best option because you can only contribute $6,000 a year if you’re under 50 ($7,000 if you’re older). You can set up an IRA on any brokerage account, and they come in two forms: traditional IRA contributions are made before tax and grow tax-free, and you don’t pay tax until you make withdrawals in retirement. With a Roth IRA, on the other hand, contributions are made after tax, but you never have to pay tax on qualifying growth or withdrawals. In general, a traditional IRA makes sense for those who think they’ll be in a lower tax bracket when they retire, since withdrawals are taxed at your current tax rate. Meanwhile, those who think their tax bracket will rise should stick with a Roth.

I am retired, how long will my savings last?

A single 401(k)

You can contribute up to $20,500 to a Solo 401(k) account, and many brokerages also allow you to have a Roth 401(k) option in the account. Additionally, you can make a profit sharing contribution to the account as a business owner. This amount can be up to $40,500 (or 25% of eligible profits), for a potential total of up to $61,000.

A SEP IRA

When incomes rise, a Simplified Employee Retirement Plan (SEP) can help you catch up on the years you may have skipped on retirement savings while you were building the business. You can contribute up to 25% of your income, or $61,000 per year, whichever is less. (The deadline to open a SEP is Tax Day, so you may still have time to open an account and make contributions that count toward your 2021 taxes.)

3. Remember that your business is not your nest egg

Many entrepreneurs tend to view their business as their primary retirement asset. Often they plan to sell the business in retirement or turn it into a cash cow that allows them to live comfortably while someone else runs it. While either scenario could occur, financial planners advise entrepreneurs to make sure they take other steps to put money aside for retirement.

“You never know what might happen to your business,” Parks said. “There could be a war, there could be a global pandemic. That’s why you have to diversify.”

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