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Mark Miller: Remaking Retirement

Key Financial Factors for Boomer Entrepreneurs

Starting your own business could improve your retirement security, but going solo also poses specific personal finance challenges for older entrepreneurs, says Morningstar columnist Mark Miller.

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Mark Zuckerberg is the world's best-known entrepreneur--a poster-child for success who started  Facebook (FB) in his Harvard dorm room. But the ranks of entrepreneurs include plenty of poster children who aren't kids.

Baby boomers have racked up the highest rate of startups during the last decade, according to the Ewing Marion Kauffman Foundation, which is devoted to entrepreneurship. Even among technology startups, Kauffman research shows that the average age of company founders actually is 39--and that twice as many are over age 50 as are under 25.

In recent years, some entrepreneurs have found going solo is a sensible response to the ravages of the Great Recession, which has left so many workers older than age 50 jobless with at least a couple of decades of productive time, but with poor prospects for employment in the corporate world. For others, entrepreneurship offers a way to fulfill a lifelong itch for independence and to create a business from scratch. In many cases, small-scale business owners aren't even leaving the industry where they've worked. Many are launching businesses serving the companies they once worked for full-time--taking advantage of low startup costs and leveraging networks of contacts built up over a lifetime.

"Contacts are extremely important," says William K. Zinke, president of the Center for Productive Longevity, a nonprofit focused on career options for workers over age 55. "You can get started with a small amount of money with the technology we have available now, and with the economy slow, the cost of services you need are lower than when it's strong."

Entrepreneurship isn't the right choice for everyone. It requires a taste for risk-taking, and a knack for spotting--and pursuing--the right opportunities. It's a good fit for people with some broad experience managing a business, including some understanding of sales, marketing, and finance. "If you are risk-averse or don't have an optimistic attitude, entrepreneurship may not be way to go," says Zinke. "You need to be resilient, willing to persevere and commit to a lot of hard work."

But for many over age 50, entrepreneurship offers an important path to improving retirement security by adding more productive years of work. Yet going solo also poses some special pocketbook challenges. Here are some of the key personal-finance hurdles facing potential older entrepreneurs.

Finance Yourself
Small bootstrapped businesses don't require a great deal of capital to launch, but they also probably won't generate revenue immediately. That means entrepreneurs need to maintain an adequate cash cushion to pay living expenses while starting up--about six months, on average, according to Jeff Williams, president of Bizstarters, which provides coaching and training to boomer entrepreneurs.

Start with a thorough review of household finances, looking for ways to cut costs. Also make a careful inventory of all income sources that can be relied on while you're in launch mode. This might include a spouse's paycheck or a pension benefit. You might also be able to rely on small drawdowns from tax-qualified retirement accounts without incurring penalties if you're over age 59 1/2--though many startup experts caution against liquidating 401(k)s or IRAs to finance business launches or to meet personal expenses.

"Some of the entrepreneurs we work with will use a home equity line to finance a startup, or even downsize to smaller home and use some of that money," says Michele Markey, vice president of Kauffman FastTrac, a training program for entrepreneurs that grew out of the Kauffman foundation's broader work on entrepreneurship.

For entrepreneurs in their 60s, Social Security can provide another steady income source--but take care to avoid moves that reduce lifetime payments. The worst move is filing for early benefits. Social Security's filing rules are built around the program's normal retirement age, which currently is 66. Although you can file for benefits as early as 62, monthly benefits for earlier filers are reduced proportionately for life.

What's more, early filers who are still working face a benefits penalty if their income exceeds a certain amount--$15,120 in 2013. (Social Security defines "income" in this context as wages from employment, or net earnings from self-employment). If your earnings exceed the limit, $1 will be deducted from your benefit payments for every $2 you earn over that amount. (The withheld benefits are added back to your benefits after you reach the full retirement age).

After you hit the normal retirement age, you can earn an unlimited amount of income and receive Social Security benefits. However, it's worth noting that you'll pay income taxes on part of your benefits if your income exceeds certain levels. And you may also face income-related surcharges on your Medicare premiums, which are paid by individuals with $85,000 or more in annual income and joint filers with total annual income of more than $170,000.

If you are self-employed and apply for Social Security before the normal retirement age, you will probably find that you can't draw Social Security for the first year you apply. That's because of special rules covering self-employed individuals and corporate officers. 

Control Business Expenses
If you're bootstrapping a sole proprietorship, it's critical to keep operating costs low. Williams says most ventures of this type are started from a home office and that it can be done for less than $500 per month.

The Internet and other digital technologies make it possible to operate a solo business with little or no support staff. Instead, many entrepreneurs choose to develop networks with other solo operators and freelancers, who can collaborate on projects and provide services such as bookkeeping or marketing. "The biggest expense is going to be telecommunications--phones, Internet, and the like," says Williams.

Bridge the Health Insurance Gap
Leaving the world of full-time employment means leaving behind group health insurance coverage--and if you're not yet 65, you're too young for Medicare. Enrolling in an employed spouse's workplace coverage is the best alternative; if that's not an option, you'll need to shop for coverage on your own.

"Be prepared to pay more than you expected, and for prices to rise rapidly," says Andy Landis, a retirement educator and author. "Then you can join the cadre of older self-employed individuals who count the months until they're age 65, when Medicare makes health insurance cheaper and more available."

The Affordable Care Act (commonly known as Obamacare) will make it easier for solo entrepreneurs to obtain health insurance starting in 2014. That's when insurers will be prohibited from turning away buyers of individual insurance policies due to pre-existing conditions; it's also when public insurance exchanges will begin offering competitive insurance plans with sliding-scale tax credits or subsidies aimed at keeping the coverage reasonably priced.

If you're leaving a job, COBRA coverage remains an option, though it can be expensive.

Setting Goals
Even for bootstrap sole proprietors, it's important to set clear financial goals for your venture. "We've learned that many entrepreneurs get into this without very clear goals for what they hope to achieve financially for themselves," says Markey. "They may have a passion for something, but the balance sheet and the costs of launching the business are cloudy.

"It's important to get clear on what you want to achieve financially for yourself. This is especially important for older entrepreneurs--speed to market is a key concern, and we always encourage them to develop an exit plan before they actually launch."

Saving for Retirement
Going solo also affects how you save for retirement.

You'll be responsible not only for the employee share of Social Security and Medicare taxes, but the employer half as well--though you'll get a tax credit back for the extra taxes paid, (and for any health insurance you buy). "The good news is that you continue to earn Social Security credits toward coverage while you're self-employed, assuming you are making a profit and paying your Social Security taxes," says Landis.

And your future Social Security benefits likely won't be affected much by the career change. "You might wonder if a dip in income--hopefully temporary--will affect your future Social Security payments," Landis notes. "But since Social Security is based on a 35-year average of your earnings, a few years of decreased earnings generally have little impact on your payment amount."

You also have several options for retirement saving, including a solo 401(k), SEP-IRA, or Simple IRA. Making the best choice will depend on how much you plan to save, whether you plan to have employees now or in the future, and how much flexibility you want, notes Morningstar's Christine Benz.

Resources and Further Reading

  • Kauffman FastTrac: An off-shoot of the Ewing Marion Kauffman Foundation, FastTrac offers a 30-hour curriculum for would-be entrepreneurs of all ages and recently added a course focused on boomer entrepreneurs. Course modules focus on business concept development, market research, startup costs, and basics of financing a business. Classes are being expanded to locations around the United States.

  • The Encore Career Handbook: How to Make a Living and a Difference in the Second Half of Life: Encore.org is a nonprofit focused on midlife career reinvention with social purpose. In a new book that will be published in January 2013, Encore's Marci Alboher offers a nuts-and-bolts look at what it takes to launch a new career, including a chapter on entrepreneurship. Learn more about the Encore movement here.

  • Bizstarters.com: Jeff Williams is one of the nation's top coaches for would-be entrepreneurs over the age of 50.

  • RetirementRevised.com: I've put together a page of further resources and videos on 50-plus entrepreneurship at my website.

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.

Mark Miller does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.