Entrepreneurship, Self-Employment and Retirement

N. Sappleton, F. Lourenco, N. Sappleton, F. Lourenco

• Publisher: Palgrave Macmillan
• Year: 2015
• Print ISBN: 9781137398376
• eBook ISBN: 9781137398390
• Topic: Business
• Subtopic: Business General
• Index: Business

This book presents a collection of nine studies which contribute to a more robust and richer understanding of entrepreneurship, self-employment and retirement in a diversity of settings, including the Netherlands, Canada, the United Kingdom, Singapore and the US, by drawing on both qualitative and quantitative data.

1

Retirement Planning, Financial Literacy and Small Business Owners

Tami Gurley-Calvez, Kandice A. Kapinos and Donald Bruce

Introduction

Retirement planning is a broad concern for individuals and policymakers alike, particularly as a larger proportion of the population is nearing and passing traditional retirement age. In particular, little is known about the financial literacy of small business owners and how they prepare for retirement compared to their waged and salaried counterparts. We use a publicly available panel data set from the United States to examine the retirement savings decisions of self-employed and non-self-employed individuals nearing retirement age.

Several studies have found that small business owners accumulate more wealth than their non-business-owning counterparts (Gentry and Hubbard 2004; Zissimopoulos and Karoly 2009; Gurley-Calvez 2010). However, small businesses (10 or fewer employees) are less likely to offer pension plans, and small business owners have lower rates of retirement account ownership and contributions than employed individuals (Dushi, Iams and Lichtenstein 2011; Lichtenstein 2010). In this chapter, we examine attitudes about retirement preparation and the degree of financial literacy for self-employed individuals (used interchangeably with the term “small business owners”) aged 50 and over relative to their waged and salaried counterparts.

Specifically, we examine retirement planning, including expected retirement age, time spent thinking about retirement and age retirement saving begun. We consider expectations about Social Security, including expected benefits for a typical 70-year-old retiree and whether the individual would work longer if Social Security benefits were cut. We use previously used measures of financial literacy by examining individuals’ responses to questions regarding interest, inflation, investment diversification and safe rates of return.

Understanding financial literacy and expectations about retirement income is important given the dramatic change in the pension landscape in the United States over the last three decades both with changes to generosity, prevalence and types of private pension plans available to workers and with increased concerns that many retirees may be increasingly dependent on Social Security’s Old-Age, Survivors and Disability Insurance (OASDI). Private pensions have evolved from defined benefit plans, where a retiree receives a guaranteed benefit determined by a formula, to defined contribution plans, where a retiree’s benefit depends on both contributions (employee, employer or both) and market performance of the invested funds (e.g., 401(k)-tax-qualified plans common in the United States, whereby employees contribute pre-tax dollars often matched by their employers). In addition to private pensions and Social Security, retirees might participate in a savings plan such as an individual retirement account (IRA) that is separate from their employer-provided plan, which could be made with pre-tax (traditional) or post-tax (Roth) income. Individuals might also invest in other assets, such as real estate and business assets as part of their retirement savings strategy. Thus, understanding how self-employed individuals prepare for retirement has significant implications for their overall retirement income security and the adequacy of their private pension benefits and savings to augment their Social Security benefits.¹

In the remainder of this chapter, we review the related literature and theoretical framework and present our analytic strategy and results. Following a discussion of our main results, we conclude with a brief discussion of some potential policy implications of our work.

Previous literature and theoretical framework

There are several dimensions on which we might expect older small business owners to differ with respect to their wage-and-salary counterparts in retirement preparation: financial literacy, retirement savings, beliefs and attitudes about Social Security benefits, investment behaviour and responses to financial shocks such as recessions. The act of establishing a small business exposes an entrepreneur to a broader spectrum of the financial marketplace and thus may equip him or her with more information in the area of financial literacy than the wage-and-salary counterpart. In a similar vein, evidence suggests that individuals in occupations with exposure to more financial content (such as bankers, economists or high-level executives) have greater financial knowledge than those who work in occupations with less daily exposure to financial content (such as nurses, teachers or truck drivers; Helppie, Kapinos and Willis 2010). This spillover from daily exposure to financial concepts in certain occupations (or industries) may also apply to small business owners who manage their business finances and make capital and financial investment decisions frequently. While it is unclear whether this exposure will result in better long-term financial and retirement planning or savings behaviour, self-employed individuals do seem to have greater financial sophistication on average (Helppie, Kapinos and Willis 2010).

The accumulation of retirement savings is likely to vary as well. Establishing a small business requires the prior accumulation of at least some amount of wealth, and evidence suggests that those with greater access to wealth or windfall financial gains are more likely to become self-employed (Evans and Jovanovic 1989; Evans and Leighton 1989; Holtz-Eakin, Joulfaian and Rosen 1994; Dunn and Holtz-Eakin 1995, 2000; Fairlie 1999; Bruce, Holtz-Eakin and Quinn 2000; Fairlie and Krashinsky 2006; Zissimopoulos and Karoly 2007; Zissimopoulos, Karoly and Gu 2010). This could be an indication that entrepreneurs are likely to save more for retirement than wage workers.

Entrepreneurs frequently rely on a significant portion of their own personal wealth to establish their small business, however. Entrepreneurs frequently rely on readily accessible forms of debt, including credit card debt, for the purposes of getting their new ventures off the ground (Scott 2009). This reliance on personal savings and the ability for wage employees to save for retirement through employer provided retirement savings vehicles (Dushi, Iams and Lichtenstein 2011) suggests that small business owners may accumulate lower amounts of retirement savings than wage workers. Although retirement savings vehicles also exist for the self-employed (e.g., IRAs, SEPs and Keogh plans), the entrepreneur must make the effort to establish those accounts through banks and other financial service providers. Given the recent findings that retirement savings decisions among wage workers are often driven by default options (e.g., on average, workers save more when they are defaulted into savings plans and must opt out), self-employed individuals may be less likely to establish such accounts given that their default is to have no account (e.g., Madrian and Shea 2001; Choi et al. 2003; Thaler and Sunstein 2003; Carroll et al. 2009). However, the lack of a default savings plan does not necessarily mean lower overall savings. Gustman and Steinmeier (1998) find that the amount the self-employed lack in pension savings is offset by investments in their businesses and real estate assets.

Beliefs and attitudes about the Social Security system might also impact the relative retirement preparation behaviour of wage workers and the self-employed. Until the early 1980s, the self-employed enjoyed relatively lower payroll (Self Employed Contributions Act, SECA) tax rates than wage workers (Federal Insurance Contributions Act, FICA). They might have mistakenly assumed that Social Security benefits would be commensurately lower for their earlier working years and could have increased retirement savings in response. By the same token, the self-employed may be more likely to notice their SECA taxes, given that they must compute them on their tax returns, while FICA taxes are automatically calculated and withheld by employers on behalf of wage employees. Social Security wealth may also vary systematically between wage workers and the self-employed due to differential payroll tax rates (prior to 1984) and earnings histories across these two diverse categories of workers. This possibility of differential salience of payroll taxes for wage workers and self-employed workers and the extent to which that might translate into differential savings behaviour and financial literacy has not yet been explored in the academic literature.

Given that entrepreneurs must devote considerable portions of their wealth to their small business, it is possible that they might exhibit more conservative retirement savings in an effort to provide some balance against their entrepreneurial risk (Gentry and Hubbard 2004). Recent research has suggested that entrepreneurs are no more risk-loving than wage workers, however, when it comes to choosing what share of their portfolio to hold in relatively risky stock investments (Gurley-Calvez 2010). Again, expectations about Social Security benefits might also have resulted in different savings patterns and portfolio allocation strategies between wage workers and the self-employed. In essence, those with greater annuitised wealth in Social Security and defined benefit plans might save less in individual retirement accounts like 401(k)s and IRAs.

Our chapter contributes to the literature on how self-employed individuals prepare for retirement. In particular we investigate how self-employment correlates with financial literacy, retirement savings and beliefs and attitudes about Social Security benefits and investment behaviour.

Data and methods

We utilise the Health and Retirement Study (HRS), a longitudinal nationally representative data set of the US population of individuals 50 and over ...

Table of contents

• Cover
• Title
• Introduction: Pre- and Post-Retirement Self-Employment: Broadening Existing Horizons
• 1  Retirement Planning, Financial Literacy and Small Business Owners
• 2  One Size Does Not Fit All: Uncovering Older Entrepreneur Diversity through Motivations, Emotions and Mentoring Needs
• 3  Entrepreneurship in a Context of Pending Retirement: The Lived Experience of Older Entrepreneurs
• 4  Becoming an Entrepreneur after Retirement: Results from a Longitudinal Study in the Netherlands
• 5  What Drives Post-retirement-Age Knowledge-Based Self-Employment? An Investigation of Social, Policy and Individual Factors
• 6  Entrepreneurship in Mid-career
• 7  Self-Employment among Canadian Seniors: Trends and Financial Well-Being
• 8  Hybrid Entrepreneurship during Retirement: Comparison of Motives and Aspirations
• 9  Self-Employment around Retirement Age
• Index