For high income individuals earning into seven figures, why should they consider investing a portion of their disposable income into the stock market? Especially if they own a business or medical practice that provides a stable source of income and holds significant value. These individuals tend to have a high level of comfort when assessing their long-term financial security, and in most cases, this is the correct assessment.  However, as time passes, financial FLEXIBILTY will be significantly lower than the average income household, and without developing a plan to increase liquid assets, it is likely these high earners will face complex decisions with only a few options to choose from.

The key differentiator between ultra-high-income earners and the rest of the pack is liquidity, which provides flexibility, especially for high earners in their younger years. However, maintaining flexibility throughout retirement requires strategic planning, particularly when it comes to income replacement, business ownership, and the cultivation of generational wealth.

Maintaining Lifestyle Spending in Retirement

High income earners may feel like they are checking off all the boxes for retirement by maxing out 401-k contributions, profit sharing, super funding 529 plans, back door Roth conversions, carrying little to no debt, but when the decision to retire comes, the traditional retirement accounts will not replace current income levels.  In a simple scenario, a 45-year-old high-income earner with $1 million in annual spending who has maxed out his or her company 401(k) plan since age 27 and will continue to do so until age 65 and earns a 7% annualized return. This retirement account will be valued at approximately $4.5 million at age 65, which will not meet the annual lifestyle spending needs, forcing the individual to stay involved in the business or sell it to create liquidity. This may seem like a simple binary decision, but it often is not. Business ownership can become extremely sentimental and selling to create liquidity could be off the table.

If the same individual were to invest $250,000 into a taxable investment account returning 7% annually until age 54 (10 years), this account along with the retirement account would grow to meet the annual spending needs ($1MM) through the life expectancy age of ninety. This would significantly increase flexibility for the business owner in terms of the involvement in the day-to-day and timing of the sale if it were to be sold.

Business Ownership and Strategy Flexibility

The focus of high net worth or ultra-high net worth families later in life is not maintaining lifestyle spending, it is building generational wealth and transitioning it in a tax effective manner. If we stick with the 45-year-old business owner, he or she does not know if they plan to sell the business, bringing in outside management, or if one of their three kids is interested in taking a leadership role down the road. It could be another 10 to 20 years before a decision needs to be made on the future of the business. However, it is critical that the business owners position themselves to be able to make a decision that fits their needs decades down the road. Having set aside liquid assets into an investment portfolio will increase flexibility and reduce the chances of being put into a corner to sell the business.

If the 45-year-old opts to bolster liquidity and allocates $250,000 annually until age 65 and scales back lifestyle spending to $750,000. At a 7% annualized return, this strategic approach could yield a +$40 million investment portfolio in liquid assets over the next 35 years, meeting the needs of lifestyle spending but also providing liquid assets that could exceed the value of the business, or at least a significant portion of it.

The alternative scenario, where the owner does not accumulate liquid assets, could present challenges down the road. For instance, if only one of the three children decide to take an active role in the company, and there are not sufficient liquid assets to treat each of the kids equally, all three kids may take on ownership. which leads to conflicting long-term goals. More than likely this will lead to a deterioration in family relationships.

Accumulating liquid assets outside the business or practice can also enhance operational flexibility. When there are extreme shifts in an industry’s operational environment, ie. supply chain issues due to COVID, having excess liquidity will allow an owner to make decisions that will benefit the business for the long-term, which includes retaining key employees, taking market share, and potentially taking on an acquisition at a steep discount.

Generational Wealth Formation

Increasing liquidity can support the seamless transition of a business from one generation to the next, nonetheless, it also increases the flexibility in building generational wealth. A portfolio with a high withdrawal rate (assets withdrawn divided by the initial portfolio value) will be built to meet the income needs of the current generation, which requires bonds and lower risk assets. With a higher denominator, the withdrawal rate will be significantly lower, allowing for a higher allocation to stocks and other risk assets that have a higher return over time. This higher risk approach is focused on the time horizon and risk profile of the next generation.

As wealth accumulates, strategic gifting strategies can be used to reinforce financial security for the next generation. Gifting assets before death is unique to each family and requires a customized approach to support specific goals. For example, gifting into an account for each child with the goal of $1MM in liquid assets per child by age 30, will likely have different goals for each child. One may be entrepreneurial focused and wants to take on more risk with a business idea, while another may decide to become a one income household to have a parent at home with the young children. Whatever the situation might be, gifting strategies often increase family involvement through structured annual meetings that foster the continuity of the family’s values, thereby cultivating stewardship over time.

Speaking of stewardship, enhanced liquidity expands the opportunity to pursue philanthropic goals, and can be seamlessly integrated into family discussions and meetings. Vehicles such as Donor Advised Funds or Family Foundations not only offer tax advantages but also serve as instruments for passing down the family's legacy from one generation to the next.

Increasing flexibility within a family has numerous benefits, and developing long-term projections that incorporate both liquid and non-liquid assets can help display the need to utilize certain estate planning strategies, which can mitigate potential estate taxes that could burden the next generation. The current 40% estate tax can drastically reduce wealth if the inadequate estate plan is put in place.

Designing a Plan

At Beese Fulmer, our dedicated portfolio managers specialize in crafting Financial Foresight Analyses (FFAs) carefully tailored to each client's unique circumstances. FFAs serve as comprehensive roadmaps, displaying how current saving and spending behaviors will shape long-term financial security. This process often requires close collaboration with the client’s CPA and/or estate attorney to formulate strategic plans that include income replacement, private business ownership strategies, and building generational wealth, while considering family values and legacy.

Our FFA process is deeply interactive between the client, their service professionals, and Beese Fulmer. By generating multiple scenarios, we provide clients with a range of options, allowing them to select the strategy that aligns best with their preferences and objectives over time. As circumstances evolve or new opportunities emerge, the existing FFA serves as a dynamic foundation, enabling ongoing discussions and adjustments to adapt to the latest developments in the client's financial landscape.