What if I told you that in 13 years, you could go from $0 saved for retirement to accumulating enough wealth to live off your savings forever? It’s easier than you might think. With deliberate action to budget your personal expenses, execute proper tax planning, and leverage the power of compound interest, you’ll be well on your way to retirement.
Here are the three basic ideas:
Maximize happiness while minimizing costs. Take a hard look at what you spend your money on and ask yourself the question, “Does spending this money make me truly happier?” Research has shown that purchasing stuff rarely makes us happier. On the other hand, removing daily annoyances, like long commutes or a cluttered home, have shown to improve happiness in the long term.
Tax winning strategy. The tax code provides business owners several options to simultaneously save on taxes and retirement. Common options include the solo 401(k), SEP IRA, and SIMPLE IRA. These retirement plans are a must when planning for your retirement.
Leverage compound interest. Here’s the crucial one. The stock market has historically given investors between 7-12% return on their investments over the long term (10 plus years). So if the stock market gives you a 8% return over a 9 year period, you will double the money you invested. There are few passive revenue activities that will consistently give you this amount of income.
To put these 3 ideas together, let’s take an example.
Let’s say Tom has a painting business that generates revenue of $300,000 a year and gives Tom a 25% profit equaling $75,000. Tom’s business is a single member LLC. So he decides to use a solo 401(k) for retirement funds in order to limit his taxable income. He also decides he wants to retire in 13 years. He currently has $0 saved towards retirement.
Tom must determine how much he needs to retire. With some reflection and budgeting, he determines that he can live happily on $30,000 a year. So he’ll need enough saved to pay himself this amount with the interest his savings generates. With a 5% return on retirement funds, he’ll need to have $750,000 to retire.
Tom is making $75,000 a year before taxes and saves $31,000 a year with his solo 401(k) and still has $30,000 left over to pay for his living expenses. Saving $31,000 a year for 13 years at 9% return on investment, he saves over $750,000.
So in 13 years, Tom went from $0 saved in retirement, to having enough cash saved to cover his annual spending forever. Not bad.
Now, let’s determine your goals...
First, determine how much you spend annually to live a happy life. Ensure you identify and remove any excess you could do without.
Next, determine how much you need to save in your retirement account to live off the interest. Multiply your annual spending times 25. Saving this amount will allow you to live off the interest from your retirement funds forever.
Next, determine how much you can save towards retirement. Enter the amount you can save into the “Annual addition” field in this calculator. Enter 9% interest in the “Interest Rate” field (if you want to be more conservative use 7%). Enter the amount of years in the “Years to grow” field you estimate it would take to hit your savings goal. Click “calculate”. Adjust the “Years to grow” field until your Future value amount is approximately equal to your savings goal. Now you have the amount of years it will take to save towards your goal.
Next, determine the best type of retirement plan for you business and personal situation. The best bet is to ask your accountant or a trusted adviser.
You’ve worked hard on your business. Make sure you take care of yourself, and set yourself up for financial freedom.