The Business Owner's Retirement Squeeze
Priya, 58, owns a bakery generating $420,000 in revenue and $95,000 in owner distributions. She has $310,000 in a SEP-IRA, $40,000 in cash, and a $260,000 mortgage at 5.9%. She wants to retire at 65 with $70,000 per year after tax and has no other savings. Her equipment is aging and may need $60,000 in replacement within three years. She asks whether she can afford to increase her SEP contribution to $60,000 per year, which would absorb most of her discretionary cash flow.
1. Evaluate whether the proposed $60,000 annual SEP contribution is feasible and appropriate.
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The advisor must test the contribution against cash flow and liquidity, not just tax deferral. Distributions are $95,000; a $60,000 contribution leaves $35,000 for living expenses, taxes, debt service, and the $60,000 equipment risk. That is not feasible without a reserve. The mortgage at 5.9% costs roughly $15,400 per year in interest alone on $260,000, and the equipment replacement is a near-term certain liability. A better structure is a contribution sized to leave an emergency reserve and a sinking fund for equipment, perhaps $20,000-$30,000, then increase as the reserve builds. The advisor should also compare SEP limits to a solo 401(k) or defined-benefit plan, which may permit larger deferrals at her age, but only if cash flow supports the commitment. The answer is a phased contribution tied to a liquidity floor.
2. What must the advisor project to answer her $70,000 retirement goal, and what are the key sensitivities?
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The advisor should project the SEP balance at 65 under several contribution and return assumptions, then convert to sustainable income. At $30,000/year for seven years with a moderate return, the balance grows from $310,000 to roughly $600,000-$650,000; a 4% draw yields only $24,000-$26,000, far short of $70,000. The gap must come from business sale value, continued work, or lower spending. Key sensitivities: contribution level, return sequence, equipment capex, and whether she sells the bakery. The advisor should present a base, downside, and delayed-retirement case, and identify the levers: work to 68, sell the business, reduce spending, or downsize the home. The conclusion should be that the goal is not supported by savings alone and depends on business value and time.