Converting Equity To Income
The key for converting business equity into retirement income is to get good help and get it early. Creating a business plan tends to be more challenging than creating just a retirement plan alone, so advice and time are precious planning tools. Sebastian's case offers a glimpse into how an owner can deal with this vexing yet manageable challenge.

Prioritize. Working with his advisors, Sebastian must first prioritize his goals and needs. It is unlikely that he can tackle all of his business and personal issues in one master plan. Breaking the plan into bite-sized pieces makes success more likely. Key first steps include securing an investment banker, gauging the interest and financial status of his daughter and CFO, and assessing possible outside buyers. Once this market overview is completed, Sebastian can start planning his exit.   

Create an Exit Plan. The exit planning process involves more than just having an attorney draft a buy-sell agreement. Particularly with privately held businesses, there are many options above and beyond simply selling the business. Sebastian might consider various forms of capital transfer, essentially getting retirement cash now while planning to exit later. The concept of financing the business and then selling to his daughter or CFO is one such example. Here are two other examples of capital transfer techniques that might work for Sebastian:

He could sell part of his stock through an employee stock ownership plan. An ESOP can be a highly tax efficient way for Sebastian to access and diversify his ownership equity. He would sell a part of his business to his employees via the ESOP and reinvest the equity in a broader portfolio of retirement assets. So, for example, his company could borrow $10 million from a bank and use that amount to fund an ESOP for the benefit of the employees. The ESOP would in turn buy a comparable amount of his stock, and he could then reinvest that amount, potentially tax deferred, into a diversified stock portfolio.

He could use compensation as a means of accessing business equity. Because of Sebastian's age and salary, a qualified defined benefit plan might not only be an employee benefit; it could also generate an attractive retirement income for Sebastian. Add a nonqualified deferred compensation agreement to the package, and his retirement income will be size able. Especially if the business is to be sold internally, these combined plans can help ease the cash flow of buying out his interest.

The retirement packages would be a liability that lowers the value of the business, and the payments would be a way for the buyers to pay Sebastian on a tax-deductible basis. Sebastian would get approximately the same amount as if he sold his business directly, but using qualified and nonqualified retirement plans is more tax efficient for the buyer.

Execute. An exit plan without execution is like a mission statement without strategies. Timing and action are crucial with private businesses because of the realities of the marketplace. It takes time to identify buyers, arrange financing, draft documents and move when the market is favorable. Additionally, most tax strategies require several years of lead time in order to be effective. For example, to fully reap the tax benefits of converting from C to S Corp income tax status, an owner should allow as much as 10 years before sale. Similarly, with the referenced qualified and nonqualified retirement plans for Sebastian, the plans will need several years of contributions to build sufficient retirement capital.

The conversion of wealth into retirement capital is a challenge for any person of affluence. If the wealth is concentrated in a closely held business, the challenge is compounded, but not impossible. Recognizing the principles of private business ownership and then executing them can yield a source of tax-efficient and diversified retirement capital. It may take more time and more professional assistance, but business owners can enjoy the same financial security in retirement as their wealthy counterparts.

Steve Parrish, JD, CLU, ChFC, is National Advanced Solutions Consultant for the Principal Financial Group. With more than 30 years experience as a practicing attorney, financial planner and insurance industry executive, he frequently addresses the challenges of business owners and executives. For more information, visit