You have just sold a property. The commission check is about to arrive in your bank account. It’s party time, right? Not so fast. It’s not time for bottle service yet.
Every dollar of that commission check has a job to do, and not everything is reserved for bubbles. Knowledgeable agents know this. They’ve probably felt the pain of not having money in the right place at the right time.
That’s why many top agents we work with use a simple cash management strategy to keep all their dollars in line and working hard. You may know this strategy as the “envelope method” or the “bucket method,” or as a simplified version of Mike Michalowicz’s Profit First method. Whatever you call it, it works.
First, let’s start with your business accounts. You will need five. The type doesn’t matter; just be aware of fees and account minimums.
Your first business account is your income account. Every commission check is deposited here, but no money stays in this account for very long. It’s just a clearing account. You will withdraw all funds from this account and allocate them to the other four business accounts.
Your second business account is your tax savings account. Move 25-30% of each commission check from your revenue account to this account. This account is pretty self-explanatory. You will use the funds here to pay your estimated quarterly taxes.
Your third business account is your operating account. Move 40% of each commission check from your income account to this account to pay for your business operating expenses. Items such as salaries, lead generation, software, MLS dues, and other expenses must be paid from this account.
If you use a credit card for business expenses, pay the card balance from that account each month. This account is also where you will withdraw your monthly salary, whether you take owner draws or pay yourself a W-2 salary.
Your fourth trade account is your reserve account. Move 10% of every commission check from your income account to this account to help you through the slow selling months.
We generally recommend keeping about three months of operating reserve in this account so you don’t have to scramble to pay business expenses when commission checks are scarce in January, February and March. This account is usually depleted in the first quarter of each year and replenished between the second and fourth quarters.
Your fifth trading account is your profit account. Move the remaining 20% to 25% of each commission check from your income account to this account. Buy champagne with it, if that’s your thing. But a wiser use would be to turn those profits into investments that will grow over time – some of which will be described in the next section on personal accounts.
If you’re just starting out, go for these percentages. As your business grows, you will need to revisit them. Your tax bracket will change, your expenses will increase, and your profit margin will generally decrease (even if your total income increases), so it’s wise to review these attribution percentages at least once a year.
You know you will fund your personal accounts via W-2, or have the owner draw from your operating and profit accounts. But now what?
It’s time to optimize your personal finances, so that all the hard work you’ve put into your business isn’t wasted. The first personal account you need is your checking account, which is all about convenience.
Current accounts are not sexy. In fact, they don’t pay interest at all. But that’s not their role. The job of your checking account is to be funded to the point that you never have to worry about an overdraft. At the same time, you want to carefully avoid allocating too much capital to what is essentially a stagnant account, which can become a drag on your net worth.
We typically see this account targeted for around two months of living expenses.
The second personal account you need is a High Yield Savings Account (HYSA), which supplements your emergency cash fund. The role of your high yield savings account is, first, stability, but with the benefit of collecting monthly interest payments that are not available in a checking account.
Most HYSAs have limits on the number of transactions you can create per month without incurring any fees. While this limitation is something you should be aware of, it shouldn’t be a problem since the main role of the account is to act as a placeholder for your emergency fund in times of need.
We typically see this target around four to 10 months of living expenses.
The third personal account you need is a brokerage account, the first we cover that offers significant growth potential. Besides the potential for growth, the strongest feature of your brokerage account is that it comes with flexibility.
Unlike retirement accounts, which we’ll discuss next, a brokerage account is available for withdrawals at any time.
This availability serves two purposes:
- The ability to serve as backup to your cash emergency funds in case of need
- The ability to access the account when an opportunity arises, such as investment property
Don’t sleep on your brokerage account. This account is one part of the financial plan where we see significant growth in our clients’ net worth. We generally recommend depositing all dollars beyond your emergency fund into your brokerage account.
The fourth personal account you need is your retirement account, which offers tax advantages that no other type of account can. Depending on the style of retirement account you choose to contribute to, you will enjoy tax-deferred or tax-free growth. What is the difference?
Tax-deferred growth is the benefit you get when you make a traditional pension contribution. This can be an IRA, SEP IRA, or Solo 401(k) account. Traditional retirement contributions allow you to receive a tax deduction for the current year for the amount you deposit into your retirement account.
Conversely, tax-free growth is the benefit you receive when you make a Roth pension contribution. If the plan is drafted correctly, Roth contributions are available through a Roth IRA or Solo 401(k) account.
While a Roth contribution provides no tax benefit today, 100% of the contribution and growth in this account will be tax-free upon withdrawal after age 59.5. So what’s better?
It depends on your situation, but your financial planner will be able to run scenarios to help you determine the answer. Now you might be thinking, “But I thought you told me to put all my excess profits in my brokerage account? Where to find the money to finance retirement?
The amount you can contribute to a retirement account is limited and varies based on your earned income, age, and inflation each year. Since this can be such a moving goal, we recommend that you save all of your surplus in the brokerage account to grow without any limits, and then transfer your maximum amount from the brokerage account to your account annually. pension once your contribution has been calculated.
The fifth personal item on our list is not an account nor is it a requirement, but it does offer the benefit of leveraging your skills as a real estate professional – investment property .
There are two reasons why investment property makes sense for agents:
- You have a pulse on your niche market and can identify an opportunity better than average.
- You can create equity through a lower transaction cost by drafting the agreement yourself.
But beware of going overboard with real estate investing as an agent yourself.
For the same reason it makes sense for a tech employee to diversify their company-granted stock options it makes sense for real estate agents to build net worth de-linked from real estate as that asset class.
Be sure to maximize your skills as a real estate agent while prioritizing diversification of your net worth. Financial success as a realtor is driven by the decisions you make both within your business and your personal finances.
And with those 10 accounts in place, you’re building the infrastructure to operate both sides at the highest level. So keep popping the bubbly and celebrate your success; remember to manage your finances in such a way that the party lasts long after retirement.
Jordan Curnutt, CFP, is a Certified Financial Planning Professional for the most productive real estate professionals who want to strategically manage their wealth, optimize variable income, build balanced net worth, and mitigate what is likely their biggest expense. personal, taxes. Contact Jordan on Facebook, Instagram and LinkedIn.
Michael Kilner is the former COO of a leading real estate team and an independent brokerage. Now an IRS-accredited tax practitioner, Kilner and his team at Kilner Advantage provide accounting and advisory services to real estate agents and their teams across the country.