The 8(a) Program can offer incredible opportunities: sole source contracts, set-aside competitions, mentor-protege relationships, SBA business training and much more.
But for business owners older than 59 1/2, getting admitted to the 8(a) Program can be very difficult: unlike their younger counterparts, funds these owners have saved in traditional retirement accounts will likely count against the 8(a) Program’s $250,000 adjusted net worth cap.
How is this fair? (Spoiler alert: in my opinion, it ain’t).
The 8(a) Program regulations are chock-full of arcane eligibility criteria, but today we’re concerned with only one: “economic disadvantage.” To be admitted to the 8(a) Program, a company’s disadvantaged owners generally must fall below certain net worth and income thresholds.
On the net worth side, for initial 8(a) Program eligibility, an individual’s net worth must be below $250,000. But I call this the “adjusted” net worth threshold, because it excludes certain things, including the owner’s equity in the individual’s primary residence and the 8(a) applicant company itself.
It would be bad public policy to discourage Americans from saving for retirement, especially with one news story after another reporting that the country is facing a retirement savings crisis. Fortunately, the SBA regulations provide this exclusion:
(ii) Funds invested in an Individual Retirement Account (IRA) or other official retirement account that are unavailable to an individual until retirement age without a significant penalty will not be considered in determining an individual’s net worth.
Great! Problem solved, right?
Well, sure, if you’re young enough. But what if you’ve hit “retirement age?”
That term doesn’t mean the age when a person actually retires. Rather, for 401(k) plans and IRAs alike, it means the age when an individual can withdraw funds from the plan without a tax penalty. That magic number is 59 1/2. (I’m sure there’s a complex legislative story around the “1/2” part, but the IRS and my kids are the only ones I know who seem particularly enthused by “half birthdays”).
Now, you might think, “but wait! I don’t plan to retire at 59 1/2! Or even 59 3/4!”
If so, you’re not alone. The average American retires around age 63. And business owners aren’t necessarily average. One survey indicated that 42% of business owners plan to retire at 65 or later. Another survey found that one-third of small business owners intend to work indefinitely, and of those who plan to retire, the average anticipated retirement age is 67.
Perhaps most striking, the same survey showed that the average American small business owner is 60.3 years old. That’s right: according to this data, the average small business owner is older than “retirement age.” That’s a heck of a lot of small business owners in their 60s and older.
That brings us back to the 8(a) Program. What happens when one of these older business owners applies? Well, if he or she has been saving for retirement, and the retirement accounts in question no longer have a withdrawal penalty after age 59 1/2, the SBA counts every dollar saved for retirement toward the $250,000 cap.
If the SBA’s regulations aren’t clear enough on this point, the agency’s 8(a) Standard Operating Procedure leaves no room for doubt that older business owners, like Tommy and Davey, get hosed. The SOP instructs SBA officials to calculate net worth using a series of five steps. Step 1 begins with adding the individual’s total assets and subtracting total liabilities.
Here’s Step 2:
Then, subtract the value of any legitimate retirement account that has a penalty for early withdrawal of funds. This exclusion does not apply if the individual is of retirement age and can withdraw the funds without penalty.
The emphasis, of course, is mine.
So there you have it: if you’re below “retirement age,” funds you’ve saved in 401(k)s, IRAs and the like probably won’t count against you for 8(a) Program purposes. If you’re above retirement age, these funds very likely will count against you–regardless of whether you plan to retire anytime soon (or ever).
Harry, the owner of Har-Ball Cleaners, Inc., is 50. Harry has diligently saved in a 401(k) since he was 22, aggressively tilting his portfolio toward stocks. After a long bull market, he has accumulated over $1 million in his account. Harry’s net worth, excluding his equity in Har-Ball, his 401(k), and home equity, is $225,000.
Result: Because Harry is under 59 1/2, his 401(k) account balance is excluded from the SBA’s net worth analysis. Harry’s adjusted net worth is below the $250,000 threshold, so Harry likely will be considered “economically disadvantaged” for purposes of initial 8(a) Program eligibility.
Shari, the owner of Shar-Care Medical Staffing LLC, is 62. She loves being a business owner and intends to work indefinitely. Shari started saving for retirement later in life, but now has $125,000 in an IRA. Shari’s net worth, excluding her equity in Shar-Care, IRA, and home equity, is $225,000.
Result: Because Shari is over 59 1/2, the SBA will not exclude the funds in her IRA. Adding back the $125,000 produces an adjusted net worth of $350,000. Shari likely will be considered “not economically disadvantaged” for purposes of initial 8(a) Program eligibility.
Harry seems quite a bit wealthier than Shari. In fact, according to this handy investment calculator, if Harry’s 401(k) generates a 7% annual return and Harry contributes an additional $18,000 a year, Harry will have nearly $2.6 million socked away by the time he reaches Shari’s age–about 21 times Shari’s current retirement savings. But according to the SBA’s 8(a) Program rules, Harry is economically disadvantaged; Shari is not.
As another Harry might have said, “Holy Cow!”
To be fair, I have a bone to pick with the entire net worth component of the 8(a) Program eligibility rules. After all, you can have a low net worth because of difficult life circumstances–or because you blew all of your money on things like $80,000-per night hotel suites, $50,000 pet fish, $5,000 hamburgers, and other financially questionable purchases. A one-size-fits-all net worth threshold discourages saving while encouraging frivolous spending and high-interest consumer debt. That’s terrible public policy, but it’s a rant for another day.
So let’s get back to Harry, Shari and their retirement accounts. It doesn’t seem fair that Shari is tagged with every dollar in her $125,000 IRA while Harry’s cool $1 million is completely disregarded merely because he’s younger. Indeed, in a nation where 59 1/2 isn’t the typical retirement age for anyone, much less small business owners, why should the SBA penalize older owners like Shari for celebrating that magical half birthday?
In my view, things would be fairer and better from a public policy standpoint if the SBA just dropped the age limit and excluded everyone’s retirement accounts from the net worth threshold. The SBA could just say that so long as the money is in a retirement account, it doesn’t count. If it gets pulled out, it does count. Pretty easy.
While this would seem to be the best solution, the SBA seems to want some assurance that disadvantaged individuals won’t access funds in retirement accounts during the 8(a) Program term. An early withdrawal penalty, though, is just that: a penalty. It discourages withdrawals before retirement age, but doesn’t prevent them. The 401(k) early withdrawal penalty, for instance, is 10%. That’s not ideal, but our friend Harry could pull his entire $1 million account today for a $100,000 penalty, leaving him with $900,000 (less taxes)–still a heck of a lot more money than Shari.
So, SBA, how about this? After exempting retirement accounts from the net worth calculation, simply have all 8(a) applicants sign a pledge not to access their retirement accounts during the course of 8(a) Program participation. You could back it up by saying that accessing retirement accounts without SBA’s prior approval would result in termination from the Program. And if that wasn’t good enough, you could tack on one of those super scary lists of potential other consequences for breaking the pledge. (Debarment! False Claims! Fifteen yards and loss of down!)
Sure, you’d probably need to make some allowances for required minimum distributions and the like, but there are a lot of smart retirement planning people out there who could help craft the policy. Done right, you’d have a win-win: a policy that better achieves the apparent goal of preventing owners from accessing retirement funds during 8(a) Program participation, while giving the many, many American small business owners over 59 1/2 a fair shot at the 8(a) Program.
Look, SBA. I know I rag on you every now and then. Don’t take it the wrong way: overall, from Headquarters on down, you’re doing a great job supporting small contractors. But great ain’t perfect, and part of my job, as I see it, is to try to spark discussion about areas of your government contracting programs that could be improved.
This is one of them.
In my practice, I’ve seen wonderful and deserving companies denied the opportunity to participate in the 8(a) Program merely because the owners were over 59 1/2 and had (wisely) saved for retirement. I don’t think that’s fair.
I hope, SBA, when you think about it, you won’t, either.