Financial planning for brokers: Maximizing Exit Strategies

One of the key reasons independent insurance brokers sell their businesses is to create a logical retirement and exit strategy, which also releases some of the value of the business today. This creates a tremendous opportunity, as often the deal includes a combination of cash, publicly traded shares, and sometimes a promissory note.

The broker must now decide how to allocate and plan for freed-up wealth to maximize his/her personal financial position. As well, many brokers are so busy running their businesses they have not spent much time on their own personal affairs. A key question brokers may ask is, “what is the best way to deal with my freed-up capital and, when can I afford to retire?”

The following case study provides some insight into the options in planning for retirement under the new ownership structure. Currently, a broker’s company has been acquired by one of the consolidators, and he/she has received cash and publicly traded shares that contain restrictions as to when they can be sold. The broker wants to know if he/she will be able to retire in three years at age 60. His/her current financial position is as follows: RRSPs = $ 250,000.00; spouse’s RRSP = $250,000.00; home value = $400,000.00 (with a mortgage of $ 100,000); cash = $600,000.00 (resulting from the company merger); and shares = $1 million (in escrow). The recommended steps for this individual are as follows:

Update personal balance sheet. This step will provide a current financial picture, showing what is owned and owed, and will allow the individual to best determine how the cash can be allocated to maximize returns.

Spend time developing personal goals. The broker should spend some time upfront to determine how much capital will be needed to retire. To do this he/she should look at both day-to-day living expenses and lifestyle events.

To do so, it is perhaps best to segment these personal expectations as follows. Day-to-day expenses are the daily expenses that are needed to live. This would include items such as food, accommodation, gas, insurance, taxes, and other expenses that are required on an ongoing basis. Lifestyle events can have either a positive or negative effect on an individual’s assets. For example, events such as travel, new cars, and the weddings of children all cost money. However, likewise, an event such as selling a cottage or downsizing a home will generate cash inflow. Spending time in making the best estimate about which of the foregoing situations could occur would enable the broker to determine if retirement will be possible at his/her chosen time.

Allocate assets based on needs

The broker should allocate financial assets based on his/her needs and desires. This will help to plan for the future. The recommended ways to place those assets are as follows:

Short-term assets

These are the monies that are needed today to be used for purchases or to pay off debt. In a broker’s case, debts such as a mortgage that is not tax deductible for business should be paid off, as this creates a higher rate of return than many investments. For example, if the interest rate is 7% on a debt, at the top tax bracket, 14% must be earned in an investment to break even, however, paying off debt is guaranteed. This also has the added advantage of increasing cashflow. The normal order to pay off debts is based on interest rates, such as credit cards, loans, followed by mortgages.

Lifestyle assets

These are assets that in all likelihood will not be sold at retirement or used to create an income. This broker has a home worth about $400,000 on which the mortgage should be paid off. The broker and his/her family will continue to use this as their main residence, and it forms a source of cash in the future, when they may plan to sell the house, as it becomes too much to handle in advancing years. Other assets that may fall into this category would be cottages, chalets, time-shares, yachts, and other assets that would continue to be used in the future.

Business assets

The shares that this individual owns would be considered business assets, and in the future may be his/her greatest source of wealth. The reason that they are still considered business assets even though they are publicly traded shares is that they cannot be sold due to restrictions they bear.

From a long term retirement standpoint, the value of the shares should be taken into consideration, however, in this case due to the broker’s age, they cannot be counted on as retirement income since an income will be needed prior to the shares being 100% liquid. In forecasting, moderate growth in the value of the shares and conservative dividend payments should be used. For younger brokerage owners, other investments should be made to reduce the risk of having all their assets tied up in the shares of one company.

Retirement income assets

These are the assets the broker in question would use to create an income in the next three years. These are assets that he/she cannot afford to lose — so a diversified portfolio should be developed to create the income and growth that will be required. This account should be treated and managed as the broker’s own pension fund, and designed to provide a source of income for life without the threat of running out of money. For this individual, his/her RRSP accounts and most of the cash from the sale of the business would be placed under this category of assets.

Play money

This last account is one which can be used for special situations or for aggressive investments. It is recommended that the broker not allocate any more than 10% of his/her total investments to this category. This is the account that would be used as speculation funds for individual aggressive stock trading, or for making bets on a specific investment sector, such as technology. The key aspect of this account is that if money were lost, the consequence would not affect his/her retirement lifestyle. A home run may be hit with the account, but a “strike out” may just as easily be final the outcome.

Retirement income planning

Based on the preceding analysis, the broker has determined that his/her financial requirements are as follows: Day to day Expenses = $80,000.00 (annual spending indexed to inflation); lifestyle events = $10,000.00 (annually to age 80 for winter vacations); $10,000.00 annually for golf; $20,000.00 for grandchild’s education in 15 years; $30,000.00 per year for long-term care for one spouse from age 85 onwards.

For this broker, assets were allocated based on the above, with different rates of returns for the various portfolios — from a very conservative portfolio to a balanced portfolio. These were used in comparison with conservative rates of growth for the company shares. While the returns may look low — these long-term averages are the prudent ones to use for planning. Essentially, the process is to determine what type of portfolio is required to give the broker the best opportunity to achieve his/her goals.

The recommendation for this broker is that a pension fund approach be developed with a balanced investment portfolio. This will provide the best chance to achieve desired income goals if the shares of the company do not do as well as expected. If the broker is too conservative with his investments and RRSPs, there is a very real chance of running out of money. The balanced portfolio’s greater growth will allow the broker the day-to-day income needed, and the growth in shares will provide the extras that may be desired in the future, and also provide an estate for the next generation.

Furthermore, by having the investments and RRSPs providing the main source of income, the broker has more freedom to sell shares in the future at opportune times, rather than when he/she must. This also reduces the risk if any dividends on the shares are not what was expected, or the share values fluctuate widely from one year to another. This type of planning must be updated annually to take into account any changes in spending requirements, tax changes, and to examine what will happen when shares can be sold as the restrictions are reduced.

The process that this individual worked through in determining his/her goals, allocating assets, and compiling the “what if” scenarios forms the backbone of a long-term personal financial plan. Other key issues that will need to be examined in completion are tax strategies to maximize after-tax income in the future, and the estate planning process.

Each individual should go through this type of process to examine the trade-off in retirement income planning among portfolio type, income desired, retirement date and desired estate goals. If this type of planning is done, the individual will be in a position to make specific decisions and develop a life plan to achieve his/her specific goals.