Start small biz and save for retirement?

(Money Magazine) -- Question: I'm a 40-year-old single woman who earns $75,000 a year and has $150,000 in savings and $60,000 in retirement accounts. I work for a small company, but am hoping to start my own business within the next five years. My questions: Am I saving enough now for retirement? And should I be doing anything differently once I become self-employed? -- M.Z., Auburn, California

Answer: Let's start with the issue of whether you've been saving enough for retirement up to now.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

Ultimate Guide to Retirement

• Getting started
• 401(k)s & company plans
• Investing
• Annuities
• IRAs
• Self-employment plans
• Pensions and benefit plans
• Social Security
• Insurance
• Estate planning
• Living in retirement
• Getting help

If you limit the analysis solely to the $60,000 you have in retirement accounts, then you're probably behind where you want to be given your age and salary.

For example, if you go to our What You Need To Save calculator and plug in your info, the tool will tell you that you'll need to save about 16.5% a year for the rest of your career to be able to retire at age 65 with 80% of your pre-retirement salary. That savings rate may be doable, but it's ambitious, and certainly well beyond what most Americans actually put away.

But does it make sense to exclude that other $150,000 in savings just because it's not in accounts specifically earmarked for retirement? After all, if you add that 150 grand to your $60,000 retirement kitty, you've got $210,000 saved. Plug that amount into our calculator, and the picture changes dramatically.

You'll see that the percentage of salary you need to save going ahead is just below 10%. That's much more manageable, especially since any matching funds your employer kicks into a 401(k) count toward that figure.

Normally, I would say that someone who is single and hasn't mentioned big future commitments like college tuition or a house down payment should probably consider her total savings stash (minus enough for an emergency fund) in assessing whether she's on track for retirement.

But I'm a little reluctant to do that in your case. Why? Well, since you're planning to start your own business, I can't help but wonder how much of that $150,000 in savings might go into that venture.

Of course, even if you plow the entire one fifty into your new business that doesn't mean the money disappears. It would represent your equity in your new venture. If your business blossoms, you might end up earning a nice return on that investment, perhaps even more than you would by investing that money in mutual funds and such within traditional retirement accounts.

On the other hand, as I'm sure you know, the success rate on new small businesses isn't exactly encouraging, as only half survive even five years. So for the purposes of gauging your retirement readiness, I think you should probably exclude any savings you plan to invest in your business. You can reverse that decision later on should your business turn out to be a big hit. For now, though, I think it pays to be conservative and act as if you won't have access to those funds at retirement.

As for whether you should be doing anything differently once you become self-employed, I'd say the answer is yes. In fact, you may want to make some changes even before you go out on your own.

In the time remaining at your current job, concentrate on saving as much as you can. One reason is so you can devote enough money to your new venture to give it every chance of success. But you also want to pour as much as possible into retirement accounts over the next five years, as cash can get tight and saving for retirement more difficult in the years immediately after you launch your business. And if your current employer offers matching funds, why not take advantage of that freebie while you still can?

When you do start that biz, your focus initially will be on assuring you have the cash and working capital you need to keep it running and growing. But as soon as it's feasible, you should also turn your attention to taking advantage of some of the tax-advantaged retirement accounts that allow the self-employed to sock away some sizeable sums. Two that deserve special attention are the SEP-IRA and the solo 401(k) (aka the self-employed 401(k)).

With a SEP-IRA, you can contribute up to 20% of your self-employment income (after deducting one half of self-employment tax) to a maximum of $49,000 this year. So if your self-employment income is $100,000, you can contribute as much as $20,000. (You'll often see the limit couched as 25% of self-employment income. But that is the percentage of self-employment income after deducting the SEP-IRA contribution. So if your self-employment income before the contribution is $100,000 and you contribute $20,000, that would leave net income of $80,000 after the contribution; $20,000 equals 20% of $100,000 and 25% of $80,000.)

A solo 401(k) can be an even sweeter deal, as not only can you contribute 20% of self-employment income as a self-employed business owner, you can also make an employee contribution of up to $16,500. Your total contribution as owner and employee can't exceed $49,000, however, with one exception: If you're 50 or older, you can also make a catch-up contribution of up to $5,500. That contribution doesn't count toward the $49,000 limit.

I've sketched the outlines of these accounts here, but you'll want to take a closer look at them, which you can do for SEP-IRAs by clicking here and for solo 401(k)s by clicking here.

Finally, on the investing front, you may want to consider going with a more conservative strategy than you otherwise would in your other investments, especially those not specifically earmarked for retirement, to offset the additional risk you're incurring on the money you devote to starting your own firm.

I'm not suggesting that you've got to hunker down completely in bonds and cash. You still need your money to grow over the 25 or so years you'll have until retirement. But you may want to dial back your overall stock exposure a bit, say, 10% to 15%, just to dampen volatility a bit help assure you'll have sufficient savings on hand to help you out through a difficult period should your new biz bite the dust.

But let's think positively. Let's hope your fledgling venture takes off and generates enough profit to allow you to save big bucks. And if things really go well, maybe you'll be able to arrange things so that the business itself supports you in retirement.