Retirement looming for entrepreneurs
Within the coming 15 years, more than half of the country’s small business owners are expected to retire – but are they ready?
Canadians are aging, and Canadian entrepreneurs are aging even faster. According to a recent CIBC report, the number of self-employed who are nearing retirement (ages 55 to 64) has been rising rapidly in recent years, growing by a whopping 7.5% annually since the beginning of the decade. This is double the growth rate seen in the 1990s. One-fifth of small business owners (or more than 500,000) are planning to retire within the next five years, and another 30% will retire by 2020. That is, within the coming 15 years, more than half of the country’s current small business owners are expected to retire. Chartered accountants have a role to play in helping small business owners make a smooth transition into retirement.
Exhibit 1
Retirement fast approaching for entrepreneurs
Exhibit 2
Projected retirement date for entrepreneurs
Succession planning is becoming a critical issue
By the end of the decade, an estimated $1.2 trillion in business assets poised to change hands -- the largest turnover of economic control in generations. Accordingly, faulty succession planning could have significant economic costs resulting from reduced productivity, job losses, premature sales and increased bankruptcy rates. Yet only two in five small business owners have a clear plan for exiting their businesses. Moreover, at this stage of the game, a small business principal strength — the reliance on the human capital of the owner in almost every aspect of the business — is also becoming its primary weakness, since it means adequate succession planning requires time that is often measured in years, not days or months. Still, 60% of entrepreneurs aged 55 to 64 have yet to start discussing their exit plans with their family or business partners. CAs and other financial professionals can help draw attention to the need for succession planning well in advance of the small business owner’s desired retirement date.
Note also that, among small business owners age 55 to 64, only about 15% have definite plans to transfer or sell the business to a family member (mostly to their children).
Exhibit 3
The next generation of family businesses
Another 40% of small business owners plan to sell their businesses to outside interests, with entrepreneurs in Alberta and the Central Prairies showing the highest level of intention to sell, likely reflecting the high concentration of small firms in the primary industries sector in this part of the country. Self-employed in Ontario and Quebec are less likely to sell their business — not surprising, given the dominance of service-oriented businesses where the owner is, in fact, the business.
While many entrepreneurs expect to sell their business, the assessment of its value may not be accurate. CAs can help provide the necessary tools to determine a realistic value of the business, which, in turn, will assist small business owners in determining their potential retirement income.
Exhibit 4
Planning to sell the business
Entrepreneurs closest to retirement
Considering the entrepreneurs who plan to retire by the end of the decade, there seems to be a very slim margin separating the regions other than Quebec. Small business owners in Saskatchewan, Atlantic Canada and Alberta are most eager to retire, with about one-quarter planning to exit the labour market within the next five years. Only Ontario and Quebec, fall below the 22% national average of small business owners planning to retire by 2010. The heavier concentration of entrepreneurs in service and technology-oriented businesses in these provinces, which are less physically demanding, may account for these small business owners not being in a rush to retire.
Looking at the entrepreneurs who plan to retire by the end of the decade by sector, those in tourism have the highest rate of self-employed approaching retirement, followed by those in primary industries and food. By contrast, only one in six self-employed in the technology sector plan to retire by the end of the decade. This reflects not only the relatively young age of those who operate in this field, but also the fact that the vast majority of these businesses are SOHOs (Small Office/Home Office).
Are Canadian entrepreneurs prepared for retirement?
Beyond the macroeconomic implications of small business succession, there are the microeconomic ramifications for the small business owners themselves. More specifically, are entrepreneurs financially ready for retirement? To be sure, optimism is a key ingredient for a successful entrepreneurial career. And indeed, in survey after survey, small business owners reveal this inherent optimism. But how realistic are their retirement plans?
At times, there is a gap between plans and reality. As highlighted in CIBC’s study — Canadian Small Business: Back in High Gear — the number of self-employed past retirement age who are still working is on the rise.
Exhibit 5
The number of self-employed over age 65 is rising fast
Furthermore, younger entrepreneurs seem much more optimistic about their projected retirement age, with self-employed under 35 expecting, on average, to retire at 54. At the same time, self-employed 35- to 54-year-olds believe they will retire at 59, which is much closer to the actual average retirement age of 62 for entrepreneurs. Combine this with the finding that almost one-third of small business owners do not have a good sense of their planned retirement age, and there is a real reason to believe that for many Canadian entrepreneurs a worry-free retirement is not exactly a certainty.
Exhibit 6
Retirement age – A moving target for Canadian entrepreneurs
Financing retirement
To better assess the level of retirement readiness among Canadian entrepreneurs, we need to take a more detailed look at how small business owners plan to finance their retirement.
Here again we see a clear distinction between younger and older entrepreneurs. Young small business owners plan to rely much more heavily on the sale of their business to finance their retirement needs, and less on government or corporate pensions. As entrepreneurs get older, they scale down their projected revenues from the sale of the business and upgrade their expected income from pensions. While this observation might reflect some cynicism among young Canadians regarding the sustainability of the Canadian and Quebec pension plans, it probably also reflects unrealistic expectations about the projected value of their businesses. In working with young entrepreneurs, CAs can provide an objective opinion of the value of their businesses and encourage them to explore other sources of retirement income. On average, selling the business is expected to generate roughly 30% of self-employed retirement income, while pension income accounts for 16%.
CAs and other financial and legal professionals can help entrepreneurs explore their options for a gradual transfer of ownership in their business, and perhaps their retention of non-controlling shares in the businesses as an ongoing source of retirement income for themselves and/or their families.
Exhibit 7
Planned sources of retirement income
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% |
% |
% |
% |
% |
% |
% |
|
Sell Business |
31.0 |
35.7 |
33.2 |
26.3 |
13.8 |
29.9 |
33.7 |
|
RRSP |
28.1 |
29.3 |
28.0 |
28.2 |
27.1 |
28.4 |
27.5 |
|
Other Investments/Income |
24.5 |
25.9 |
23.9 |
25.2 |
23.2 |
26.1 |
20.8 |
|
Pensions |
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|
|
|
|
|
|
|
|
100.0 |
100.0 |
100.0 |
100.0 |
100.0 |
100.0 |
100.0 |
*NB: Percentages may not sum to one hundred due to rounding or the acceptance of multiple mentions.
Entrepreneurs’ RRSP contributions
RRSPs and other investments play a significant role in the retirement plans of Canadian entrepreneurs. Those two vehicles account for more than half of their projected retirement income, with little variation across age and income groups. This is a tall order, one that requires discipline and a certain degree of investment savvy.
Are Canadian entrepreneurs contributing enough to their RRSPs? A quick look at the numbers suggests that self-employed indeed rely on RRSPs more than regular employees. Almost 70% of small business owners own them, compared to 55% of paid employees. Self-employed are also contributing more to their RRSPs: the average annual contribution is just over $6,000. These contributions are 25% higher than those made by regular employees who belong to employer-sponsored pension plans, and more than 50% higher than regular employees with no corporate pension. When we consider that the average self-employed person earns 10% to 15% less than people who work for someone else, these contributions are even more significant.
Exhibit 8
Small business owners contribute more
But that’s where the good news ends. A closer examination reveals a dark cloud on the retirement horizon for Canadian entrepreneurs. Only 35% of self-employed contributed to their RRSPs in 2003, and only one-fifth maximized their contributions. The median RRSP contribution constitutes roughly 10% of median income — well below the 18% allowed. Not surprisingly, the share of those who maximize their RRSPs rises with age, but even in the age group of 55 to 64, only one-third of small business owners maximized their RRSP contributions in 2003.
Exhibit 9
Maximizing RRSP contributions
What’s more, despite the alarming demographic picture described earlier, the pace at which small business owners contribute to their RRSPs is, in fact, declining. While the median income of small business owners increased by 10% between 1999 and 2002, the median RRSP contribution made by self-employed during the same period fell by 3.8%. Consequently, the cumulative unused RRSP room for self-employed has been rising rapidly over the past few years. At the end of 2003, it stood at an astounding $370 billion, or close to $20,000 per small business owner with an RRSP. CAs, along with banking advisers, can help educate entrepreneurs about the benefits of RRSPs and the need to supplement planned retirement income from the sale of the business with increased RRSP contributions. Particularly for young entrepreneurs, who can benefit from compounding interest over a longer time horizon, this education is a very important element of retirement planning.
Exhibit 10
Maximizing RRSP contributions
The slowing pace of RRSP contributions by the self-employed is not uniform. It masks a clear divergence among regions and demographic groups. The fastest deterioration was in Atlantic Canada, where average unused contribution room rose by close to 45% since 1999 — clearly reflecting the slow income growth in the region for the past few years. Only small business owners in Quebec increased their RRSP contributions between 1999 and 2002.
Exhibit 11
Falling RRSP contributions among entrepreneurs
Small business owners with relatively low income were responsible for the entire decline in RRSP contributions between 1999 and 2002. At the same time, the average contribution made by those self-employed who earn more than $80K a year rose by 13%. Furthermore, virtually all the decline in total RRSP contributions was concentrated among men, with the number of women contributing, and their actual dollar contribution, rising by 2.3% and 4.2% respectively between 1999 and 2002.
Exhibit 12
Higher income and female entrepreneurs contribute more to their RRSPs
While financing retirement is a priority for many people, this is especially true for those who are self-employed. Canadian entrepreneurs are not as ready for retirement as they can and should be — and time may be working against them, given the growing number of “seniorpreneurs” (small business owners over the age of 55). Beyond individual retirement planning, with $1.2 trillion in business assets poised to change hands by the end of the decade, succession planning must be a key focus for entrepreneurs to avoid creating a negative ripple effect throughout the Canadian economy. Professional advice and diversifying sources of income can help ensure a worry-free transition to retirement for Canadian entrepreneurs.
This article is based on a report by CIBC World Markets, “Are Canadian Entrepreneurs Ready for Retirement?” The original report is available in the resource centre at www.cibc.com/smallbusiness.
NB: Unless indicated otherwise, the data sources used in the study are the 2004 CIBC Small Business Outlook Poll, Statistics Canada and CIBC World Markets. Also, unless indicated otherwise, small businesses in this study are defined as firms having between one and 15 employees including the owner and having revenue under $5 million for the year 2003. Unless indicated otherwise, “don’t know/not stated” responses were excluded from the percentages from the 2004 CIBC Small Business Outlook Poll.
For more discussion of the report findings, go to “Warning: shock ahead,” May 2005.
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