Many small business owners dream of the day they can sell their business and retire to a life of opulent leisure. Well, perhaps not opulent. Comfortable. That dream usually involves a cash sale of their business (perhaps at an unrealistic price), preferably as early as possible. Age 65, for many, is an abstraction. We may be hurtling quickly toward it, but most retirement dreamers don’t want to wait that long.
How sophisticated is the average small business retirement dream? And is it a retirement plan? The purpose of this article is to encourage small business owners to think holistically about their exit strategy and beyond – not just about how much money they’ll have in the bank, but how to maximize it, how to preserve it through tax deferral strategies, and creative ways to make that money go further. The goal you’re working for, after all, is an improved quality of life, whatever that means to you and your family.
Maximizing Value for Sale. Small business owners typically focus on revenue and profit margins. A good accountant will advise you to focus on cash flow. It’s a subtle distinction, but sometimes an important one. The goal should be to constantly increase the velocity of money through your business, because your profit margin applies to each dollar – the faster they come in, the faster you profit. Strong cash flow, and refining your methodology to generate it, is crucial to the value of your business.
Your business needs assets to be marketable. If your business consists primarily of you personally applying your skill and expertise, it isn’t worth much when you’re gone. A client list and a phone number isn’t your key to retirement. To the extent possible, focus transitioning your business from personal effort to income generating assets.
Tax Deferral. Most small businesses are subject to generous exemptions from capital gains taxes, and understanding these exemptions is critical. Additional deferral vehicles, such as like-kind exchanges, may also play an important part in your tax deferral strategy, depending on the nature of your business. The tax code is out of your control, but the structure of the sale of your business is within your control. Don’t wait until there’s a deal on the table to consider the tax implications. Explore your options in advance.
Think International. Most people don’t even consider retiring in a foreign country. If they do, they may quickly rule it out for a variety of reasons, such as the inability to speak a foreign language (and lack of a desire to learn), family considerations (like grandchildren) or lack of faith in foreign institutions to protect their property. These are all very valid reasons to rule out foreign retirement. But there is a significant reason to keep on open mind:
Money. And lots of it.
Consider, for instance, that a luxury condominium or home in a desirable American retirement location can easily cost you $1 Million. Or, if you are planning on keeping your home, your equity can only be accessed by paying interest. Both of these choices will set your retirement fund back considerably. That capital gains tax you deferred (if done properly) when selling your business and contributing to your 401(k) will be subject to ordinary income treatment when you withdraw it. Annuities purchased with pre-tax dollars will be taxed as income as well.
Here’s an example: a 55 year old couple decides to sell their business, and ends up with $1.5 Million in liquid assets to purchase an annuity, guaranteeing them lifetime income. Their modest goal of living on $80,000 per year in their home may seem attainable, but the truth is they aren’t even close. When taxes, inflation and medical costs are considered, they’ll be roughly $270,000 in the red by the time they reach 65. Social Security saves the day, right? Wrong. With paltry cost of living adjustments that don’t keep pace with inflation, and a majority of income still being taxed as ordinary income, the couple is likely to be more than $400,000 short by age 75. That means they need roughly $1 Million more to retire than the $1.5 Million they have available. It will take another eight years or so for their retirement fund to support their plan.
Now consider the same couple decides to spend ten years abroad. Keeping an open mind, they visit a number of countries that lack the two factors that are devastating to their American retirement plan: high cost of living and high taxes. This particular couple settles on Medellin, Colombia.
I know what you’re thinking.
Most people know Medellin, and Columbia generally, for drug cartels and kidnappings. Especially the kidnappings of Americans. That image, which ceased being a reality more than ten years ago, makes Medellin a missed opportunity for most. Medellin is, in fact, a beautiful, vibrant, growing, and modern city. It has attracted substantial investment from Europeans, especially Spanish nationals in recent years, but the cost of living remains exceptionally low. A two-thousand square foot luxury condo in a neighborhood you could easily mistake for an American one will cost you between $110,000 and $180,000.
Back to our couple. Now that they’re moving, they can unlock the equity in their home (let’s say $350,000) and invest that money aggressively. After all, their total liquid assets have increased to $1.85 Million. Their cost of living is cut in half without sacrificing their quality of life, and they can largely meet their needs with the capital gains from a combination of investments in the S&P 500 index ($500,000) and municipal bonds ($850,000). The capital gains tax in Colombia? 10 percent. The same couple, with starting with the same assets, now hits 65 with almost $40,000 more than they retired with. That’s a $410,000 difference from staying in the U.S., but more importantly, it makes the dream of retiring at 55 a reality, because it took $1 Million less to make it happen. Now, at age 65, they can return to the United States if they choose, and with their social security benefits they can afford to maintain that $80,000 standard of living (adjusted for inflation).
I used Medellin for my example because I spent ten days there and got to know the city, and saw the opportunity firsthand. It is by no means the only place where an international retirement strategy can work. If your tastes run more toward an English-speaking, less tropical locale, the Isle of Man may be an option. The small U.K. protectorate actively seeks people they refer to as “Tier 1” investors and entrepreneurs with more than $1 Million to invest in Isle of Man-based businesses. Located between Great Britain and Ireland, the Isle of Man has a decidedly different climate and culture from Medellin.
Adjusting to a new country is difficult, and it isn’t for everyone. But it’s worth asking yourself – would I prefer to work an extra eight years, or spend those years living well in a new and interesting place? It might be worth taking a few vacations to find out. ,
If you own a small business and are thinking about retirement, I would be happy to field your questions, whether they’re about selling your business or beginning to consider an international retirement strategy.
 The example discussed was developed using a basic financial model, accounting for differences in taxation, inflation, standard of living, real estate costs, and other considerations. While I think it is substantially accurate, it is intended to stimulate thought, not provide definitive tax or financial advice.
 By European standards, the Isle of Man is an extremely affordable place to visit. Rates at the Best Western in the village of Douglas start at $64 per night.
 You can expect to pay between $800 and $2000 for a 10-day vacation in Medellin, including airfare.