Are you eligible for a self-funded retirement plan?
By Jenny LescohierFebruary 22, 2022
Construction is an industry made up largely of small- to medium-size owner/operators who are naturally concerned about funding their retirement years. Financial solutions run the gamut between the tried and true and some lesser-known, nontraditional approaches.
Registered Investment Advisor Scott Eichler is the author of Don’t Play Chicken with Your Nest Egg: How to Create Income from Your Investments and Retire Securely, a book which tackles this weighty topic in a simple and readable way, without a lot of jargon, because let’s face it, few who work in construction have the time or the interest in deciphering the technical language of financial planning.
Based in Southern California, Eichler is founder of Standing Oak Advisors, a firm dedicated to “business owners who have an uphill climb to make.” Eichler began his career in construction – and has a family history in the building trades – so he has experience with the challenges facing today’s construction firms.
CONEXPO-CON/AGG 365: What prompted you to write a book about financial planning?
Eichler: When I started writing the book, I looked at the families I’ve worked with and all of them had one common goal: Everybody wants to at some point be financially independent. Not everyone wants to retire necessarily, but they still want to get to a point where they don’t need to depend on their job for survival.
Financial planning doesn’t come naturally to everyone. Some people simply lack interest in the strategies and tools it takes to successfully plan for their financial future, while others don’t have the knowledge or skills; they just need a helping hand.
CONEXPO-CON/AGG 365: What’s an example of a financial strategy that matches the needs of people who run construction companies?
Eichler: An Employee Stock Option Plan, often referred to as an ESOP, is suited to a specific set of mid-size contractors who have a successful business, enjoy consistent profitability and have an existing management team.
Those general contractors are interested in learning how to improve bonding, win bigger jobs and increase efficiencies, and an ESOP allows them to value their business and use that value to grow with a lighter tax burden than they might’ve otherwise found.
What we can do, for example, is set up a separate company inside your ESOP because an ESOP can own a lot of things, for example, a supply company. This doesn’t work for everybody, but for some people that are turning over a lot of product - sticks and bricks, for example – they can make their product markups work for them in the long run through this plan.
An ESOP allows you to basically keep the markup. You don’t have to worry about writing it off. In an ESOP, there’s no taxation on growth.
Most contractors pay taxes on their profits at the end of the year. But if you can split out the portion of the profit that stems from those markups and put it back into the business, you can have a lot of cash available for the next job. Bonding gets larger and a whole bunch of other benefits result that can make it possible for your business to grow a little bit faster.
CONEXPO-CON/AGG 365: Explain what’s exactly happening to that profit you mentioned?
Eichler: To make it super simple, say you have a supply company. Let’s say ABC Corp is your main company and you decided to start up another one which is fully owned inside of the ESOP. Because the ESOP has a very preferentially treated tax system – similar to a 401K – it treats profits in a similar way.
For example, if you own Apple in your IRA, you own a portion of the company. In that same sense you own a company inside of your ESOP. If there are any profits for that company, typically that company would be taxed, except it’s in tax-deferred umbrella, so it doesn’t get taxed in the usual way.
CONEXPO-CON/AGG 365: Could this work for all types and sizes of contractor?
Eichler: It’s best for seasoned companies. If you need every ounce of profit to make ends meet, this is not the right solution.
I got a call from a client who said, “We’ve got a million dollars in profit. What are we going to do?” I live in California, where taxes are high. I’m thinking, he’s going to lose almost 40% of that money to taxes. No one likes to say a profit is a problem, but it can create an issue. But this is the type of thing that a seasoned contractor can take advantage of.
The trick is in figuring out – before painting yourself into a corner – where is the money is coming from and what money don’t I immediately need? That’s when we can put a portion away so it’s not taxed right away but can work for the company in the meantime.
CONEXPO-CON/AGG 365: If you are a seasonal contractor, is this an efficient way of protecting your profitability?
Eichler: For a profitable contractor, this is simply a way to defer taxes on property.
To clarify, in my industry, we have something called present value and future value... what’s the value of $1 today vs. the value of $1 20 years from now. Taxes and inflation can really kill future value.
As inflation occurs you’re buying more expensive equipment and supplies, and one might think that’s terrible, but it’s not, because those increases get passed along to somebody else at a 10% to 15% markup. This helps address the inflation problem, but we’re still stuck with the taxation problem.
By being able to defer taxes, you really supercharge the ability to save money for retirement. Think of it like an IRA. Everybody likes that they put the money in and can write it off, but the real value of the IRA is the ability to let the money sit there and grow and not be taxed. It’s the ability to defer those taxes all the way along until you retire.
The government realizes it’s good to allow people to save their own money in preparation for retirement, and that’s essentially what an ESOP does. It’s similar to a 401K or 403B. All those things are in similar sections of the IRS code. They’re all just built a little bit differently to provide different benefits to different people.
CONEXPO-CON/AGG 365: So with an ESOP you’re not evading taxes, just paying them at a later time when it’s financially more secure to do so?
Eichler: You’re likely going to pay more in taxes in the end, but you’re going to structure it and you’re going to have more money as a result. I ask people, would you like to have $100 at retirement and pay $10 in tax, or would you rather have $400 in retirement and pay $40 in tax?
To be clear, I have Republican clients and Democrat clients. No matter where your financial philosophy falls on the political spectrum, you are going to be paying your fair share of taxes.
CONEXPO-CON/AGG 365: Is this a new, or perhaps underutilized tool?
Eichler: It’s not new, but it’s very underutilized. I think the reason is because it’s different from a 401K which it’s broadly applicable. To make this work, you need to find a financial advisor that works with ESOPs. It’s built for middle-market companies that have a healthy profit margin but are not billion-dollar companies yet.
We typically look at privately held business with two to five decision makers.
CONEXPO-CON/AGG 365: What are three questions our audience members can ask to determine if this will work for their business?
Eichler: The first question is, do you have three years of profitability?
Second, are you at $1 million of profit? To clarify, I don’t mean have you made a million dollars each of the last three years. We just need to see that you’ve built up to a consistent point of profitability.
The third question is, do you have a leadership team in place? Do you have employees? Most of the companies we do this for have over 20 employees. This is important because it speaks to the maturity of the business and its ability to continue its performance.
It wouldn’t be the right fit for a company where they’ve got $1 million of profit, but they’ve got just two guys that lead the company. What if one guy dies and the other is completely overwhelmed? They couldn’t operate the business on their own, so they’d lose profitability.
CONEXPO-CON/AGG 365: What’s your message to those companies for which an ESOP is not the right solution?
Eichler: The bottom line is that even if the ESOP doesn’t work for your business, there are plenty of other things that can work for you.
What I see a lot of contractors doing is essentially trying to build their business without a set of plans. In the same way that no contractor would walk onto a job that doesn’t have architectural plans done yet, the same should be true for their business. They should have plans that map out the next 10 years and beyond.
All business owners want to know how they can improve profits, that’s what everybody’s focused on. In the end, I’m your subcontractor to help you keep more of your money.