Retirement Planning for Small Business Owners - Important Factors Our CPAs Want You to Know

Retirement planning is often a missing feature of “working for yourself” life. There’s always too many other things to think about and too many other places for the money to go.

This leads to two common compensation situations in small business:

1. Owners who compensate themselves via salary typically do so at below market rates. They’re thus limiting their access to the two main mechanisms for retirement savings in Canada: the inflation adjusted defined benefit Canada Pension Plan and the tax deferring Registered Retirement Savings Plans.
2. Owners who compensate themselves solely via dividends have access to neither of these mechanisms.

A first step towards retirement planning for small business owners is to think past these situations.

In the startup phase of small business, you’re hustling to generate demand for your products and services and to find a business model that works. For a business model to work, it must allow you to progress through the following stages:

• Stage 1: Stop losing money.
• Stage 2: Stop losing money while paying yourself a market salary.
• Stage 3: Make money and put the systems in place that will allow you to transition to being paid as an investor rather than as an employee.
• Stage 4: Welcome to the promised land where you work only when you like and 100% of your compensation is flowing to a holding company via a tax free intercompany dividend.

During the early stages, you may feel there’s not much left, time or money, to set aside for retirement. This is a mistake. If you don’t pay attention to retirement sooner, when you have more options, you’ll find yourself in the uncomfortable position of needing to pay a lot more attention to it later, when you’re left with fewer options. The years go fast.

We try to correct this mistake where we can at Origami. We do it by working backward.

• Our CPAs help our clients decide where they want to be, financially, in the near and not so near future.
• We take their goals and map out the series of financial steps that their businesses need to take achieve those goals.
• Then it’s a matter of helping our clients stay focused — making sure their plans and efforts point as straight toward their goals as possible.

In the rest of this post, I want to cover why many small business owners sidetrack retirement planning when thinking through their business and why this short term thinking can prove costly.

Small business owners prioritize control: being in charge of “their own thing” versus being a part of someone else’s “thing.”

For most people, work means working for someone else: 30 to 40 years filling up a resume, collecting a paycheque, saving the difference between income and expenses, and investing, all to finally earn the freedom to choose what to do or not do every day.

If you’re a small business owner, you’ve flipped this script. You’ve already gained control of how you spend your time. But this control comes at a price.

Control over your working life results in more variable and unfavorable returns than what you could expect from a conventional career. And depending where you are in your entrepreneurial journey, you may not be feeling great about paying that price right now.

(Control over your working life also offers more interesting and rewarding returns and possibilities. That’s the promised land of Stage 4. Let’s save that for another post.)

The price of control is financial insecurity and sacrifice.

Because you control the financial performance of your business, you control your personal income. You decide when and how much to pay yourself. You can work more and make more. Or work less and make less if, say, you have other priorities.

The real drama and tension in the small business story happens when you work more — more than you’ve ever worked — and still make less.

That’s because small businesses are hungry, especially new ones. Hungry for time and attention, hungry for money and resources. When anything comes up short anywhere, you, the owner, have to make up the difference.

You’re the primary (and least demanding) source of financing for your business. Your salary and the personal capital you put into your business are the plugs that makes the financials balance.

Taking less money than you could otherwise earn working for someone else is one way of making the numbers add up at the end of the month. It’s one of the prices you (and your family) pay for control. And because of the power of compounding, that price can get very high.

Compounding is powerful, but it needs time and consistency to do its magic.

Benjamin Franklin summed up the power of compounding this way: "Money is of a prolific generating nature. Money can beget money, and its offspring can beget more, and so on." Or, in plain English, money makes money, and the money it makes makes more money. You can see this process in action for yourself in the Wealthsimple Retirement Calculator.

According to the Calculator (and assuming its conservative rate of return), a 25 year old saving $1,000 a month until 65 will have $1.74M in retirement savings. Someone who starts 10 years later, at age 35, will have $943K. How about someone who starts at 45? They’ll end up with $466K. Every 10 years of investing roughly doubles the amount of savings available in retirement. Seen from another angle, every 10 years of delay in saving for retirement shrinks the eventual nest egg by half.

The keys to compounding are time and rate of return. The earlier you start, the more time your money has to grow. The other factor is consistency. The more consistently you contribute to your savings, the more fuel you give the compounding engine.

But that isn’t the whole story. Sometimes, from a retirement perspective, forestalling early and aggressive savings makes sense if it affords you an opportunity to earn a substantially higher return later on.

Warren Buffett, perhaps history’s greatest compounder doesn’t advise that young people take the path of the 25 year old laid out above. Instead, Buffet tells young people that the best thing they can do is invest in themselves. He points out that foregoing aggressive savings to develop an exceptional skill or a business is entirely sensible if it enhances your future earnings enough over a long enough time frame.

And if you’re 35 or 45 instead of 25, the advice still holds, though the payouts have to be higher. Sam Walton didn’t open his first Walmart until he was 44 years old but developed the skills he needed to create a Walmart sized success operating small retail stores over the preceding 17 years.

For small business owners, this need to balance consistent, traditional retirement investment with enhancing the earning power of their business is exactly the dilemma.

At Origami we think there is a place for both approaches. An Origami CPA Advisor can help you keep your eyes on the prize, the long term financial goal, while also helping you think through the short term challenges you face as you build up your business.

Things are unpredictable when you’re running a small business. On top of the specific issues you deal with in your industry and market, you’ll also be dealt macro issues from time to time, like pandemics and the threat of tariffs. The trouble is, when you’re hyper focused on what’s right in front of you, you could wander off course and lose your way.

In Conferences, St. John Cassian wrote that someone “who is traveling in a wrong direction has all the trouble and gets none of the good of the journey.”

Your Origami CPA Advisor wants you to get “the good” of your entrepreneurial journey. By constantly checking your results against your objectives, he or she will bring your efforts back on course so that you continue to make progress, steadily and surely, toward your target.

I say surely knowing it doesn’t always work out in business. But we want to help you recognize that situation as well. When, by taking the long view of time and money, it sometimes makes sense to walk away — and start on another journey.