At certain times in a person’s life, income and expenses change. Obvious examples are marriage or entering retirement. But more subtle transitions occur, such as a promotion to a more senior position. For entrepreneurs, changes in personal financial situation are often tied to business operations, such as planning a company’s expansion.
As people transition through stages in life, they need to be focused and deliberate about caring for their financial health.
What usually happens
Typically, people do not focus on saving and investing until age 35 to 45 because of commitments such as establishing a home and starting a family. At some point, people find themselves with excess cash flow after obligations are met. It then makes sense to save for the future.
Most people begin retirement planning two to three years prior to retirement. Until you actually see the light at the end of the tunnel, it’s hard to imagine what life will be like and to predict the income and expenses related to the lifestyle you plan to lead.
When approaching retirement, many people who have been saving for years realize they need a financial and investment plan to make the most of those savings. However, retirement planning is much easier when financial planning is handled well.
The purpose of a financial plan
A comprehensive financial plan helps you meet your current financial needs and prepare for financial stability in the future. The work involved in creating a financial plan will guide the investment plan and eventually the retirement plan. It also influences tax and estate planning.
Brooks Barks, a wealth advisor at BMO Nesbitt Burns in Saskatoon, has seen how this level of preparation can affect a person’s life. “A financial plan can change a person’s view of life. People feel in control. They know they can handle problems like disability, separation, or the loss of a loved one. They also have financial resources to enjoy life before and after retirement. This provides peace of mind knowing you have your situation under control.”
The financial planning process is not overly complex, but it requires an understanding of what is important and the implications of certain decisions.
Start by preparing a monthly budget that will define free cash flow. Then determine how investments will be structured efficiently through the use of registered accounts such as RRSPs or TFSAs or with non-registered vehicles. Careful investment planning will aid a person in achieving what is important, setting goals, and working through a variety of decisions. Each plan is unique. The issues addressed in the plan will vary from person to person. The general process of working through each point defines the content of the plan.
A financial plan can change a person’s view of life. People feel in control.
Issues that emerge
Although every plan is unique, people often face common issues:
A need for information. Many business owners and managers have been focused on building their companies or careers. Although many have accumulated some assets, they don’t know whether they will be able to fund their retirement.
Lack of free capital. Many entrepreneurs have most of their wealth tied up in their business and are uncertain about the amount or process of converting this value to personal capital they can invest.
Uncertain income. Many entrepreneurs and managers have variable incomes based on the performance of the business or a variable compensation structure. Without income certainty, it can be difficult to predict future savings and establish a rigorous saving regime.
Competing priorities. Saving goals can compete with other legitimate demands on cash flow, such as children’s education needs, capital demands of a business, and funding a lifestyle that provides a happy and comfortable family life.
Absence of a safety net. Previous generations enjoyed defined-benefit pension plans and often relied on government programs such as CPP. People are now less certain that these programs will fund their retirement and less sure about the amount of cash they will provide. The implication is that people have more responsibility to diversify their sources of retirement funds and to ensure they have adequate funds in place.
Lack of clarity on acceptable risk. When entrepreneurs have most of their wealth tied up in their operating company, they must decide on the appropriate level of risk for personal investments.
Tax planning. The decisions you make today can have significant long-term implications for the after-tax wealth that will fund your retirement. Nicholas Suderman, CPA, CA, Director of Wealth Planning at BMO Wealth Management, comments on the variety of situations that can emerge. “If all retirement income will be funded through registered products, expect to pay high income taxes during retirement years. If all retirement capital will come from the sale of an operating company, you might face a significant tax liability. It’s easiest to minimize your tax liability when coordinating decisions with all of your professional advisors in conjunction with the process of preparing a financial plan.”
Download a discussion paper titled Tax Tips for Investors by BMO Nesbitt Burns.
Philanthropy. Many people have a desire to incorporate community support into their financial plan. Some people will not need their entire savings for retirement and must make decisions on how to extract funds tax efficiently to provide the highest benefit to their charity of choice.
These issues can certainly make the financial planning process complex. Barks explains that it is important to tie these decisions together into a comprehensive plan. “When a new client is referred to me, we’ll often examine their historical financial decisions with a view of the big picture. We’ll consider the impact on areas like retirement and business succession planning, estate preservation, tax reduction, insurance, wealth protection, and philanthropy. Often, much of what they have in place is adequate. But we see the gaps too.”
Implementing the plan
The process of working through these issues will likely generate a set of actions that need to be taken. People can often simplify their situation and reduce costs.
As Barks explains, “Some of our clients who use BMO Private Banking find that combining banking and investment accounts provides a full view of your financial position and they make more informed decisions. When you have clarity, you find that managing your financial situation becomes easier.”
When the plan is in place and a person has reorganized their financial affairs, the final step is sticking to the plan. This is often the easy part. Many people feel in control for the first time in years. They are motivated to improve their situation, enjoy life today, and prepare to enjoy their retirement years in comfort.
First published in the June 2018 edition of The Business Advisor.