For Americans who aren’t confident they are saving enough for a comfortable retirement, one response is to work longer. Theoretically, this gives you more years to save and fewer years to live on savings. The math for extending your earning years makes sense, but research and anecdotal evidence suggest it’s not as easy as telling your employer you’ve decided to stay on the job until 70. In fact, working longer may require considerable thought and planning.
In the 2014 version of its annual survey on retirement, the Employee Benefit and Research Institute (EBRI) found that almost half of American retirees are forced out of their jobs due to changes at their company such as down-sizing or closure (18%), changes in skills required for their job (7%) and other work-related reasons (22%).
And a March 2015 AARP survey found that while workers between the ages of 45 and 70 have a lower overall unemployment rate than their younger counterparts, those who become unemployed after 45 have a much harder time finding a new job. And if they do, it’s often for less pay, or part-time.
Note that the first word in the EBRI acronym is “Employee.” The surveys do not include those who are business owners or self-employed. And other research suggests the parameters for retirement are different for this group of workers. A December 2012 report from the Small Business Association found that the small-business owner has a significantly later expected retirement age than an employee. In fact, the small-business owner may be less likely to retire altogether. Specifically, small-business owners in 2010 reported that they would retire on average at age 72.6, while the expected retirement age among employees was 68.4.
For older workers, transitioning to business ownership or self-employment may be a viable path to extending their earning years. These options can not only be career extenders as far as earnings, but also allow for a gradual retirement, one that moves from full-time work to flexible hours and part-time commitments, and continues to add income to the family finances.
The Logistics of Transitioning to Self-Employment
Successfully transitioning to self-employment often requires a financial re-education. The metrics for compensation are no longer as simple as an hourly wage or monthly salary; self-employed and business owners have different income tax calculations, including the amounts assessed for Social Security and Medicare. Some tax breaks may be available, but the self-employed usually pay full price for benefits; there are no employer subsidies. And tracking business expenses is a must, both for tax reasons, and to provide an assessment of one’s profitability.
Sampling advice columns from those who have successfully made the transition to self-employment, several financial recommendations are repeatedly mentioned.
• Prepare a comprehensive business plan and a budget. The intangibles of self-employment can sound wonderful: no boss, fulfilling work, flexible hours. But remember, a primary reason for considering this path is to extend or improve your saving potential. The scenario as you envision it must be profitable.
A business plan is an attempt to determine if and how you can make self-employment or business ownership profitable—if not right away, then at least in the long run. The importance of thorough research and deliberate preparation cannot be overstated.
A personal budget is a companion to the business plan. Most transitions to self-employment are not seamless, where new income immediately equals or exceeds old employment. So how will this (hopefully temporary) decline in income affect household expenses?
• Have cash reserves. Recommended amounts vary, but a sizable cash cushion is essential. As a new business venture, you need sufficient capital. Marco Terry writes in a June 23, 2015 article for theselfemployed.com, “the last thing you want is to run out of money just as your business is taking off.” Besides whatever start-up capital is required, savings for six months of living expenses is a fairly standard recommendation; in terms of cash flow, transitioning to self-employment can be a lot like losing a job.
The prospect of transitioning to self-employment could prompt changes in current savings allocations. For example, it may be prudent to suspend or decrease contributions to retirement accounts because you might need those funds before age 59½.
• Recalibrate your insurance programs. The individual, as a business owner or self-employed, is the crucial piece of financial capital—if he/she doesn’t work, neither does the business. And the only real financial back-stop for most sole proprietors is insurance. Because workers may have options to continue insurance from their current employer, adjusting insurance programs should be considered before a transition.
• Medical insurance for the self-employed and business owners is a primary concern; the potential for an illness or accident to be financially catastrophic is so great that it is imprudent to be without it. If coverage is available through a spouse’s plan, great. Group coverage through a business or professional association may be an option. And if you’re over 65, Medicare, including Part B, might work. Budget constraints may necessitate a high-deductible plan, which could affect cash reserve needs.
• Older self-employed individuals and business owners may find it challenging to secure disability insurance, as carriers may not issue new non-cancellable, guaranteed renewable policies to applicants over 55 or 60. This leaves Social Security as the only source for disability protection.
• A life insurance benefit can help assure the increased economic value of an extended career. In particular, whole life insurance can be a valuable asset for older workers transitioning to self-employment. Both guaranteed1 and accumulating cash values2 can be a source of reserves, or accessed as capital for start-up expenses. Dividends2 and loans/withdrawals3 offer management options to keep the coverage in force during periods of fluctuating income.
• Self-employment or business ownership may also require new types of coverage, such as liability insurance, or errors and omissions protection.
Explore the Possibilities
Whether self-employment or business ownership is a realistic career extender depends on a number of factors, including your skills, age, health and current financial condition. But if you’re thinking you may want to work longer, transitioning to self-employment might be a profitable career path.
• Are you considering a transition to self-employment or business ownership? A meeting with your financial professionals could be beneficial to evaluate and adjust your financial resources.
[Footnotes:]
1. All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims-paying ability of the issuing insurance company.
2. Dividends are not guaranteed. They are declared annually by the company’s Board of Directors.
3. Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59½, any taxable withdrawal may also be subject to a 10 percent federal tax penalty.
By Elozor M. Preil
Elozor Preil, RICP®, CLTC is Managing Director at Wealth Advisory Group and Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). He can be reached at [email protected]. See www.wagroupllc.com/epreil for full disclosures and disclaimers. Guardian, its subsidiaries, agents or employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.
