RSM Resources

With the widely reported underfunding of Social Security and Medicare and a decline in workers with traditional pensions, it’s no surprise that poor savings habits will force many baby boomers to lower expectations for their retirement lifestyle. According to a 2005 study by the Bureau of Labor Statistics, only 57 percent of U.S. households had at least one retirement account, and the average balance was just less than $50,000.

But, experts say, executives and business owners with far greater assets can also make costly mistakes with their retirement funds. Most often, that’s because they tend not to plan as well for life in retirement as they did in building a successful company.

"The way in which you build an investment strategy for distributing wealth is significantly different than the strategies you might use to build wealth," says Jeff Bernier, a certified financial planner and a spokesperson for the Financial Planning Association. "While senior executives are typically smart people who know their industries and businesses very well, that doesn’t always correlate to greater knowledge on personal financial planning."

As a subset of the baby-boom generation, studies show business owners want to retire well before the traditional age of 65. A recent national survey of boomer entrepreneurs by the University of Dallas indicated that three in four wanted to sell their companies and retire in the next three years. Within that group, 57 percent said their age was the main motivation for selling the business.

Still, choosing a calendar date for retirement is only part of the issue. Following a general rule, financial planners suggest that workers — especially those in high-level management or ownership roles — begin charting retirement tax and income strategies three to five years before actually leaving the company. That process should start with a candid assessment of retirement lifestyle goals. For example, tax planning for an executive who wants to make large charitable gifts during retirement will differ considerably from that of a person who needs cash to spend on personal travel or upscale hobbies.

After defining lifestyle goals, Bernier recommends executives sort through their financial puzzle. In addition to accounting for any pension funds, Social Security payments and non qualified stock options, business leaders should work with a financial planner to determine if it’s necessary to tap any qualified plan assets, such as 401(k) plans or IRAs, before age 70-1/2. It’s also wise for executives to figure out if their companies will cover the cost of non financial benefits, such as life and health insurance, after retirement. In addition to recommending debt reduction or elimination, Bernier also suggests executives take advantage of their planning window to set aside emergency cash equal to six months of average living expenses.

Once those income sources and expenses are outlined, Bernier generally suggests high-net-worth clients do two things. First, take the cash needed to support the first two years of estimated income and invest in a short-term portfolio — typically half cash and half tax-free municipal bonds. This approach, he says,essentially sets up a tax-free "paycheck" account for those two years, allowing the remaining assets to continue to grow.

The next step— investing for the long term — needs to support both the desired income level and lifestyle objectives the financial plan outlines. More often than not, that means diversifying investments that may be concentrated in company stock, deferred compensation or related vehicles.

"The first rule for any good financial planner is to help you establish an investment approach to meet all of your goals by taking less risk, and when it comes to company assets, that means understanding risk-reward trade-offs," Bernier says. "You can achieve significant wealth by having a very concentrated strategy in the right investment vehicle. But if you’re trying to preserve wealth and create an income that you can’t outlive, the numbers say you’ll be ahead with a more diversified portfolio."

Are you a business leader getting close to retirement? If so, consider the following tips to help you make better planning and investment decisions.

Don’t equate future performance with past returns. While this is a common disclaimer on most qualified investments,consider the financial wreckage the implosions of Enron, Worldcom and other companies created, where employees had most or all of their retirement assets in company stock.

"If you work for a company that’s had a great 20-year run, you can’t extrapolate that performance into the future," Bernier says. "That’s especially true for company executives, who often run the risk of being overconfident in things they think they know. Historically, the capital markets haven’t always favored that kind of investment approach."

Have a game plan for exercising stock options. Financial planners say that many executives make big mistakes with their stock options, such as exercising them as late as possible and using margin debt or a "cashless exercise" to pay for the purchase. To help avoid some of the potentially significant tax consequences that strategy can create, Bernier recommends that executives within five years of retirement start exercising "in-the-money" incentive stock options (ISOs) during the first quarter of each calendar year. Then, in first quarter of the following year, he suggests selling that stock and using the sale proceeds to buy the next round of ISOs. As a result, the executive will reduce overall tax liability, because the stock sale can be taxed at the 15 percent rate for long-term capital gains, rather than the higher ordinary income rate.

"This approach generates cash to buy new blocks of options while creating more liquidity in the overall portfolio," Bernier says. "Even if the stock falls, you can sell it as a disqualifying disposition and pay tax at the ordinary income rate. Overall, the strategy helps you avoid the market risk of holding all the options for a single exercise and the difficulty of finding cash to pay for such a large exercise."

Distinguish between market risk and absolute investment returns. A long-held belief among financial planners is that clients focus on returns relative to benchmarks — such as the Dow Jones or Standard & Poor’s indices — in a rising stock market, but shift gears to absolute returns when markets go south. The lesson for executives approaching retirement: Be aware of the prevailing economic climate and structure your portfolio to minimize bumps in the capital markets.

"Over a 20-year period, two sets of average annual investment returns may look alike," Bernier says. "But if one portfolio scores sizable gains in the first few years and then levels off, it will still deliver more cash than one that takes big hits in the first few years before recovering nicely at the end. The bottom line is that volatility matters just as much as average returns."

Get qualified, professional help. Many veteran economic observers believe the U.S. economy has entered aperiod where equity investments will not consistently deliver double-digit annual returns. That’s a good reason for executives to build a strong retirement team, which should include a certified financial planner, an accountant with strong personal tax expertise, and possibly an attorney specializing in wills and estate planning. Supported by that kind of bench strength, executives and business owners can confidently structure a retirement game plan that will enable them to retire on their own terms.