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Value Creation Blog

The 4 Boxes Of Financial Independence - Retirement Planning

Posted by Josh Patrick

exit readiness reportOne of the questions I am often asked is “how do I know if I’m financially independent?”  Many times our Clients believe that their business is all they need to concentrate on to make sure they stay on track to become financially independent.

Adam Aardvark was taking his first steps towards The Objective Review.  He was sitting with his advisor taking him through the process and was telling his advisor that his financial future was set.  When he sold his business, he would have all of the money he needed for a very comfortable retirement.

Adam’s advisor’s first step was to help him understand that his understanding of where he stood as it related to his personal financial independence might not be as strong as he felt it was.  Adam needed to learn the difference between cash flow from an active producing asset (his business) and what he could expect to get from his business after selling it (capital asset).

Adam’s business was allowing him to draw a salary of $100,000 per year with additional business profits of $250,000 per year.  Of the additional profits he made, Adam would take out $100,000 of those profits.  Between the salary and owners draw that Adam took every year, he had $200,000 of personal cash flow per year.

Adam figured his business was worth $1,500,000.  If he sold his business, he would be left with $1,200,000 after taxes.  If he got an 8% return on his investment, the income he received from the sale of this business would last a little more than eight years.

Adam immediately saw the problem he had.  He felt that he couldn’t afford to ever leave his business and have enough money so he could retire with dignity.  His Advisor then sketched out the four boxes of financial independence and explained to Adam what each of them meant.

The four boxes are:

  • The income values of your business after you sell it and reinvest the proceeds from the sale.
  • The income value of any real estate you might own that you operate your business in.
  • The income value of retirement plans or 401k plans you have.
  • The income value of any other investments you’ve accumulated over the years.

Adam said that it was all nice and good to have this theory, but how would it apply to him.  He was 50 years old and wanted to be able to retire and be in a financial position to stop working ten years from now.  He had $125,000 in his 401k plan, rented the real estate he operated his business in and had $200,000 in other investments he had saved over the years.

His advisor took Adam through his own personal four boxes exercise.  His potential incomes were as follows:

  • His business would be worth $1,200,000 after taxes.  That would provide him with income of $60,000 per year.
  • He would purchase a building to operate his business in.  The building would cost $1,000,000 and produce free cash of $100,000 per year when it was time to retire.
  • Adam would start saving $50,000 per year through his 401k plan by adding a profit sharing portion to the plan.  Ten years from now he could have $1,000,000 in this account.  This would produce $50,000 per income per year.

The three boxes his advisor sketched would provide Adam with about $210,000 of income per year.  The advisor then put the word gravy in the fourth box which is other investments.  This box would be used for special items that Adam would want to purchase over this lifetime.

Adam learned that running his business successfully was not going to be enough when it came time for him to financially be free of his business.  He was going to have to find other income sources along the road.  He now understood that the other opportunities to fund his retirement would be to either have the government help (401k/profit sharing) or to start paying rent to himself (real estate for his company).

As you think about leaving your business, it’s important to understand that usually you must fill three out of four of the boxes to be truly financially independent.

Josh Patrick

I’ve put together a Stage 3 Exit Readiness Report I would like you to have.  This personalized and complimentary report will help you understand the strong and weak points in your company.  To get this report click on the button below.

retirement planning

Securities and Investment Advisory Services offered through NFP Securities, Inc. (NFPSI), Member FINRA/SIPC. Stage 2 Planning Partners and NFPSI are not affiliated.

This article is published for residents of the United States only.  Registered Representatives and Investment Adviser Representatives of NFP Securities, Inc. may only conduct business with residents of the states and jurisdictions in which they are properly registered.  Therefore, a response to a request for information may be delayed.  Not all of the products and services referenced on this site are available in every state and through every representative or advisor listed.

Topics: retirement planning, financial planning, financial independence planning, enterprise value, business exit planning, exit readiness

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