Many CPAs are knowledgeable about financial planning, and they do an excellent job advising their clients. When planning for themselves, however, problems arise because many just do not get around to it. There is no urgency, no accountability except to their family (who usually assume it has been taken care of), and without appointments for meetings with a financial planner, there is no due date by which to get things in order. Partners or sole practitioners who have not made these preparations should consider this article a wake-up call.
The Purpose of Being in Business
The purpose of being in a sole practice or a partnership is to provide a needed service at an appropriate fee, while making a reasonable living and providing for a secure retirement at the time of your choosing. The operative statement here is “providing for a secure retirement at the time of your choosing.” Failure to accomplish this could be viewed as a failure in operating the practice. CPAs who do not want to work until their death should give serious consideration to accumulating sufficient wealth to meet their projected cash flow needs when retired. The following sources are the most likely to do so and thus should not be neglected.
Seven Sources of Future Financial Security and Cash Flow
This is the statutory income that can be expected. There are strategies to maximize this cash flow source for the balance of one’s life, but, on some basis, these payments will not be sufficient by themself to provide for a secure retirement.
Tax-sheltered and tax-deferred savings.
These include 401(k) accounts, traditional and Roth IRAs, simplified employee pension (SEP) plans, savings incentive match plans for employees individual retirement account (SIMPLE IRA), annuities, and insurance policies. Pensions are usually nonexistent for those working in accounting firms, so these are not considered. For other plans, it would be irresponsible to not contribute to the maximum extent possible. Even if it would be too costly to have a plan that would include employees, IRA contributions should still be made for the CPA and, if applicable, a spouse. An employed spouse should also maximize 401(k) or 403(b) contributions.
If other financial obligations or insufficient cash flow limit or preclude the ability to make contributions, the fee structure should be reexamined so that sufficient revenue to make these contributions is available. In the most extreme circumstances, alternatives to being in sole practice or a partner in a firm may be necessary. CPAs should also invest wisely and in a manner that can assure growth of such accounts. Leaving the funds in low-interest bank accounts is not sufficient for the long term. It is likely that the money in these accounts would need to last over 20 years, even for someone at age 70 or 75. That calls for a long-term investment strategy and an asset allocation weighted toward equities.
Savings and investments not in tax-deferred accounts.
Included here would be land, real estate, private equity, art, collectibles, and other such assets. These would be accumulated with after-tax earnings, if any. In the authors’ opinions, such savings are important, but not mandatory. Nevertheless, they should be factored into a long-term financial security plan; the greater the accumulation of total assets, the better the opportunity to take on greater risk with a portion of the funds. With time as an ally, this can further grow the portfolio. Investments or assets not providing cash flow reduce the outlook for retirement income and liquidity and should not be counted on in future cash flow projections.
Proceeds from the sale of a business or practice or a retirement buyout.
This is always precarious, as nothing is ever guaranteed until the checks clear. While a practice or business might have a substantial value on a personal financial statement, selling costs, potential employee bonuses, and taxes will reduce the proceeds. In addition, retirement buyouts are usually paid over a protracted period, do not always pay interest, are not guaranteed, and are reduced annually by taxes.
Monetization is never guaranteed, especially in a service business, where many factors can destroy value. Having a buy-sell agreement with partners can ease and simplify transfers upon disability and provide some cash flow. CPA sole practitioners should make arrangements with a local firm to service clients in the event of temporary disability, or to acquire the practice in the event of permanent disability or death.
Sale of a residence.
The value of a residence is a nice number on a statement of net worth, but not a source of cash flow. It is a sunk cost, because everyone needs to live somewhere. Children or other heirs may realize this value, but only after the homeowner’s death. In retirement, the only thing that matters is cash flow—not asset values. In the direst straits, however, inadequate cash flow in retirement can be offset with a reverse mortgage. This enables a conversion of the home’s asset value into a steady cash flow for periods of up to 20 years.
Life insurance does not provide effective cash flow for retirement unless large policies were taken out at a young age and the face value was substantial enough to withstand inflation over the span of policy ownership. The death benefit would provide assets and liquidity for the surviving spouse or children or other heirs, but will not satisfy retirement needs. Disability insurance provides a source of cash flow, but many policies’ benefits drop at age 65. Long-term care insurance, on the other hand, is an excellent way to ensure that the family’s assets will not be reduced for the spouse who does not need the long-term care.
Immediate annuities can provide a guaranteed cash flow for life. Here, a lump sum payment is exchanged for the insurance company’s promise to pay the annuity, either beginning immediately or at a later time. Some policies also provide for a deferred payout starting at age 85. If the insured’s health is poor, the payout might be increased at the inception of the policy. In addition, the guaranteed payments increase with the age of the insured. This can be very helpful in making up expected or projected deficiencies in cash flows. The authors suggest that premiums should not exceed 20% of the total investment portfolio.
Children or other family members.
This is self-explanatory. Remember King Lear’s example, however, and do not count on this as a primary source of retirement income or stability.
Leave No Stone Unturned
Are these sources guaranteed or probable? Not necessarily. The authors contend that the only guaranteed sources are Social Security, investment accumulation, and, to a lesser extent, insurance. Any healthy retirement strategy, however, should include every effort to accumulate as many retirement assets as possible for as long as possible, and to invest them wisely.