In this episode: Once the business is humming and you decide to take money out, what should you do with it? Jon Peyton covers how owners typically pay themselves and walks a hypothetical $100,000 through your personal cash flow, balance sheet and income streams. He also explains why too many successful people leave large sums sitting idle in cash.
Key insights
- Owners usually pay themselves through a combination of salary and distributions. The IRS expects a reasonable salary for the work you do.
- Use the same three lenses as the business: cash flow, balance sheet and income streams.
- A raise in lifestyle, a bigger emergency fund and new income streams can all come from the same distribution.
- Every income stream has its own tax treatment, so plan before you invest.
- Large balances sitting in low-interest accounts are a common, costly miss.
Episode timeline
- 0:00 From business cash to personal cash
- 2:05 How to take money out of the business
- 3:45 The “reasonable wage” requirement
- 4:25 What do you do with the money?
- 5:25 Raising your standard of living
- 6:27 Topping up your cash reserve
- 8:00 Building income streams
- 8:50 An illustrative rental property example
- 12:12 Taxes on what you build
- 13:51 Too much money sitting in cash
- 14:32 Leaning on experts to save time
The episode in brief
Taking money out. Picking up from the last episode, suppose the business is doing well and you want to move $100,000 into your own pocket. Owners typically pay themselves two ways: salary, and distributions or owner draws. Salary is subject to payroll taxes. Distributions generally aren’t, which is why many owners use a combination. The IRS expects you to pay yourself a reasonable salary for the work you do, based on what similar roles earn. Work out the right balance with your CPA or enrolled agent.
Same three lenses, personal side. Jon applies the same framework from the business episode. On cash flow: if your salary already covers your bills, you may still decide to raise your standard of living a bit, say with $25,000, after years of living below what you’d like. On your balance sheet: if your income rose, your emergency reserve should too, so another $25,000 might go there. That leaves $50,000 for goals or growth.
Build income streams. The remaining money can go toward income-producing assets: bonds, dividend-paying stocks or real estate. Jon gives a hypothetical. Put $50,000 down on a $250,000 rental, and if it nets $5,000 a year after all expenses, that’s a 10% cash-on-cash return to compare against other options. You may also see the property appreciate and the mortgage get paid down over time. Every investment carries risk, though, and nothing is guaranteed.
Mind the taxes. Each income stream can be taxed differently: some at ordinary rates, some at lower rates for qualified dividends, some tax-free. How you structure and where you hold investments affects what you keep.
Don’t let cash sit idle. In nearly 20 years of planning work, Jon has repeatedly seen people with $50,000, $100,000 or even $500,000 sitting in low-interest accounts, because they’re nervous about markets, too busy to act or between decisions after a sale. If you don’t have the time to learn all this yourself, bring in experts. That isn’t a sign of weakness; it’s leverage. It frees you to focus on your business and family, with planning on the personal side and business advice on the company side working together.
Key action items
- Review your pay structure with your CPA. Confirm your salary is reasonable for your role and that your mix of salary and distributions makes sense.
- Decide where each dollar of a distribution goes. Split it between lifestyle, reserves, goals and investing before the money lands.
- Right-size your emergency fund. Recalculate your reserve whenever your income or spending changes.
- Find idle cash. List any balances earning little or nothing, and set a date to decide what each one is for.
Listen next: Episode 27: How Entrepreneurs Should Use Insurance to Protect Their Business
Value Creation Consultancy™ has since merged into Founder’s Accounting™.
Tax rules, rates and limits mentioned reflect the law at the time of recording in 2022 and may have changed since.
This episode is educational and isn’t legal, tax or financial advice. Speak with your own attorney and advisers about your situation.