San Diego Business Journal

Entrepreneurs Often Neglect Financial Planning

Small-Business Owners Need to Plan Ahead

Special to the Business Journal

Why does it always seem that the shoemaker's son has no shoes and the dentist's daughter has had an unfilled cavity for more than six months? Probably for the same reason that the successful entrepreneur or small-business owner has done little, if any, personal financial planning for themselves and their families.

Simply put, this apparent anomaly often occurs because the professional is so focused with all of their efforts centered on the successful development of their businesses, that their personal financial necessities often are relegated to the "back burner," at the bottom of a "to do" list, several pages long.

With the enactment of the 2001 tax act now almost one year into its implementation, there is no better time than the present for entrepreneurs and small-business owners alike to finally commence or revise their personal financial plans (PFP). The components of one's PFP may be divided into four segments to include trust and estate planning, income tax minimization strategies, risk management and investment advisory issues.

In addition, while many small-business owners may have felt "left out" by the 2001 tax act, the fact remains that several provisions in the act do affect financial planning for owners.

- On The To Do List: Implementing Phase I

While certainly not often cited as the most uplifting of personal financial planning topics, all individuals and especially small business owners need to ensure that their "Phase I" estate planning documents are properly drafted and meet their current goals and objectives. These include a revocable living trust, pour-over will, durable power of attorney for asset management and a similar durable power of attorney for health care decisions, often accompanied by an Advanced Health Care Directive.

In addition, for entrepreneurs and small-business owners, it is likely essential (if not already drafted) that a shareholder's agreement or buy-sell agreement be part of these initial planning documents. After all, if something did happen to you, wouldn't you want to be the one to decide what happens to you, your children and your assets, and to have your decisions implemented efficiently (both tax and non-tax issues) and effectively.

For example, upon death, absent any such document(s) reflecting one's wishes, the decedent would be declared to have died intestate and the distribution of their assets would be accomplished according to the California Probate Code and the state laws of intestacy. Such an approach would likely produce a much different result than that which one might have preferred.

The utilization of a simple will, detailing the desires of an individual with respect to the distribution their property , to whom, how much, in what form (outright vs. in trust), at what point in time, etc. , along with a designation of one's personal representative (executor/executrix) to carry out these desires, will certainly allow an individual to have their own desires imposed, rather than those of the California Legislature.

The proper creation, design and funding of a revocable living trust can accomplish the same goals and objectives as those stated in the simple will, but offers several added benefits. One of the most valuable of such benefits is the opportunity for those assets that pass pursuant to the trust document to avoid probate.

In California, the probate process offers several challenges, including added administrative costs, the public display of its proceedings and filings and the time-consuming nature of its process, to name a few. In general, the combination of a revocable living trust and pour-over will provide a better format for effective and efficient estate planning.

- Gradual Lowering Of Estate Taxes

For the vast majority of Americans and particularly for many small-business owners and their families, the most far-reaching aspect of the 2001 tax act is the gradual lowering of the estate tax rates, the increase in the exemption amount and the eventual repeal of estate taxes.

For example, in 2002, estates valued at $1 million or less won't face federal estate taxes at all, and the top estate-tax rate has been reduced to 50 percent. Furthermore, the $1 million exemption amount is scheduled to gradually rise to $3.5 million by 2009, while the top tax rate is scheduled to gradually decline to 45 percent. Because of the higher exclusion rates, Congress also eliminated, starting in 2003, the much-criticized deduction for qualified family-owned business interests.

The good news is that is seems clear that these changes should make it easier and less expensive for owners to pass their businesses on to family members. The gray cloud behind the silver lining remains, however, since there is already much debate as to whether Congress will modify the tax rates and exclusions between now and 2010, when full repeal of the estate tax is scheduled to occur.

Even more worrisome for many is that the full repeal is scheduled to end a year later, in 2011, at which point the estate-tax system would revert to its pre-2001 tax act form unless Congress acts between now and then. Notwithstanding all other issues, the current administration has made its position well known that it wants this repeal made permanent.

- Immunized Against Taxes

Income tax minimization strategies should also be considered essential parts of one's PFP. Fortunately, beyond the estate tax provisions, several other changes in the tax act affect small-business owners. One such major area involves retirement plans, where contribution maximums by employees and owners to employer-sponsored defined contribution plans such as 401(k)s, 403(b)s and simplified employee pension (SEP) plans are scheduled to gradually increase to $15,000 in 2006.

Thereafter, maximums will be adjusted for inflation in $500 increments, while the maximum annual SIMPLE plan contributions will rise to $10,000 by 2006. As with many qualified plan matters, plan discrimination testing may still preclude higher-paid employees from contributing the maximum.

Finally, the act also raised the cap on the total employer and employee contributions to a plan to 100 percent of pay or $40,000, whichever is smaller. As a result, employers also will be able to deduct more for contributions to their employees' retirement plan, for both defined benefit and defined contribution plans.

The effect of this provision may likely encourage both greater contributions that help employees, but should likewise increase funding for plans for owners such as those in a partnership.

- Risk Management Often Overlooked

Risk management, often a key business concern, is unfortunately too frequently overlooked when it comes to one's personal financial affairs. How many of us can (honestly) claim that we have recently reviewed/updated our own insurance needs and products for such items as life, disability, excess personal liability umbrella, auto and/or homeowners coverage?

Finally, no PFP would be complete without a thorough discussion and implementation of an asset allocation strategy that accurately reflects one's investment goals and objectives and is based on the specific applicable investment time horizon.

Strategic asset allocation is the process of developing a diversified portfolio by mixing different assets in varying proportions in order to meet long-term objectives and is based on risk tolerance, capital return requirements, income needs and the historical asset category return, risk and correlation.

Tactical asset allocation deploys new investments in a tax-efficient manner and is based on short-term shifts in one's portfolio caused by liquidity events (for example, sale of a business, inheritance, income needs), market conditions and changes in one's long-term wealth management goals.

As with most plans in life, the key to one's PFP success, is not just the creation, design and implementation of it, but rather its continuous review and revisions, as necessary. After all, things change. Individual facts and circumstances change, as do one's family, business and views. As a result of these changes, so do one's financial and other goals and objectives.

Likewise, we must be cognizant that laws and regulations change, as evidenced by the 2001 tax act, for example. The need for flexibility and action in adapting to such changes is essential to achieving the stated objectives. Don't just create a three-inch thick PFP book and "stick it on your shelf" in the office. Allow it to be a living, breathing document, ever-changing with the passing of time and circumstance.

Just as every small-business owner can attest to the fact that there is "nothing small about small-business," it is often said that "people don't plan to fail, they fail to plan." Entrepreneurs and small-business owners, in particular, need to ensure that their personal financial plans are in good order.

Schechter is senior vice president and wealth strategist for San Diego Private Bank, Bank of America. Benito is senior vice president and market manager for San Diego Business Banking Group, Bank of America.