Case Study: Franchise Owner Looks for to Retire Early

Like many people in their 30s, Compton resident Vincent Shepherd is trying to juggle his financial goals, including paying off debt, buying a home and investing for retirement.

But Shepherd's situation as a small-business owner and a landlord gives him some special financial-planning opportunities not available to others. In particular, both his business and his rental property can be used as assets for retirement, said Greggory J Hutchins, a certified public accountant who reviewed Shepherd's finances.

Shepherd still may not be able to quit work at 55, as he had hoped, but those advantages could give him an earlier retirement than had he continued his previous career of teaching.

Shepherd, 36, purchased a Togo's sandwich franchise in Monterey Park last year, leaving behind a seven-year career as an elementary school instructor.

"I sort of stumbled into teaching," said Shepherd, who had taken a substitute-teaching job to pay the bills while he pursued a real estate career. "I'd always wanted to go into business for myself."

Teaching paid better than real estate, which was going through a slump at the time, and Shepherd let his agent's license lapse. But as the economy improved, Shepherd revived his dream of going into business for himself. With $43,000 borrowed from family, credit cards and his retirement plan, Shepherd was able to get a bank loan for the additional $125,000 to buy the business.

Shepherd said the business was profitable from the start. In the first half of 2000, his store grossed more than $336,000, which allowed Shepherd to boost his monthly salary to $6,000. He has 24 part-time employees, mostly college students. Although he started the business as a sole proprietorship, in July he switched its status to an S corporation.

Hutchins approved of that move, saying the S corporation structure protects Shepherd from being held personally liable should the business be sued. In fact, Hutchins said Shepherd's business skills bode well for his future--which makes it all the more important to start planning for growth now.

"He has the ability to do bigger and better things," Hutchins said. "In a few years he could be pulling in a couple hundred thousand [in salary], which means he'll be playing with a much bigger playbook."

For the most part, Shepherd has kept his expenses relatively low. He lives with his mother, paying just $200 a month for rent. He invests $150 a month in a mutual fund and gives $375 in charitable contributions. He also pays between $500 and $1,000 a month toward a personal $10,000 credit-card debt that he recently transferred to a card with a 5.9% interest rate, and hopes to be free of the debt within a year.

His only other large expense--$1,074 for a mortgage payment, taxes and insurance on a home he owns--is covered by the $1,000 a month he receives in rent along with the tax break he gets for depreciating the property.

Now that his business is doing well, however, Shepherd is looking for a home in the $250,000 range. He wants to get a 95% mortgage and tap his savings for the $12,500 down payment.

Hutchins understands Shepherd's eagerness to have his own place. But buying a home would increase expenses by at least $2,000 a month, and Hutchins feels Shepherd's first priority should be setting up a retirement plan, preferably through his company.

As a teacher for the Compton Unified School District, Shepherd was covered by the California State Teachers Retirement System, which could have paid him a pension equal to 70% or more of his salary had he continued to teach until retirement age. He also contributed $500 a month to a tax-deferred annuity offered to district schoolteachers. The annuity has performed poorly, returning just 5%, although it did provide a cheap source of funds to start Shepherd's business, Hutchins said.

Now that he's self-employed, Shepherd must bear most of the burden for saving for retirement. Fortunately, he has several options, Hutchins said.

Shepherd could set up a defined-contribution plan that would enable him to put aside up to $30,000 a year for retirement.

He could also institute a full-fledged pension plan. These plans, also known as defined-benefit plans, could allow him to contribute even more to a retirement fund, because the contributions to the plan would be based on actuarial assumptions about how much money he would need in order to pay himself a set benefit in retirement. Such plans can even be skewed so that only Shepherd, and not his employees, are eligible.

Unfortunately, defined-benefit plans can be difficult and expensive to set up, especially for a small business. Failing to do it correctly could result in the Internal Revenue Service disqualifying the plan, which would mean any contributions could be subjected to taxes and penalties, Hutchins said.

A better choice right now, given Shepherd's income and the size of the business, would be a relatively new and easy-to-administer plan appropriately called a SIMPLE, for savings incentive match plan for employees, Hutchins said. This would allow Shepherd to contribute up to $6,000 of his salary annually to a retirement account. The company could then match his contributions, up to 3% of his salary. Shepherd could set the account up, with the help of a pension administrator or knowledgeable CPA, at most brokerages, allowing him access to thousands of individual stocks, bonds and mutual funds.

A potential drawback of a SIMPLE, in some employers' eyes, is that any employee who earns more than $5,000 a year must be allowed to participate and earn the matching funds. But it is unlikely that many of Shepherd's college-age workers will want to contribute--and even if they did, the costs would be low.