The Dream Within the American Dream
Rightirement is setting yourself up to be financially independent to do whatever it is that you enjoy doing. Whether that means continuing to work a few hours a week, a month, a year or none at all to generate income, rightirement takes some planning to achieve financial independence. Yet for many people, achieving financial independence appears to be out of reach. With some careful planning and some smart strategies, it becomes not only attainable, but quite possibly earlier than one would expect.
Scott Adams, the creator of Dilbert, set out to write a book on finances, but ultimately didn’t because he couldn’t fill the pages. His entire “book” is as follows:
- Make a will.
- Pay off your credit cards.
- Get term life insurance if you have a family to support.
- Fund your 401k to the maximum.
- Fund your IRA to the maximum.
- Buy a house if you want to live in a house and can afford it.
- Put six months worth of expenses in a money-market account.
- Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement.
- If any of this confuses you, or you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner, not one who charges a percentage of your portfolio.
The above “book” is elegant in it’s simplicity with generally sound advice for how to allocate capital, establish a nest egg, grow it and protect oneself from unexpected life events. It is so simple yet most people (55%) struggle to complete the first step of writing a will. While the thought of contemplating one’s death is never easy, the actual time required to complete a will is generally a handful of hours and a meeting with a lawyer or some quality commercial software. It will likely take less time than the rest of the steps on Adams’ list.
At the risk of adding words but no value to a venerable comedic genius of the office experience, pursuing rightirement takes a few extra steps to achieve faster than the average retirement age of 63. This list is summarized below:
Steps to Rightirement
- Determine a vision and goals for rightirement:
- what you want to do
- when you will reach it
- how much you will need after achieving rightirement
- Read Scott Adams entire “book” above and execute it
- Reduce all spending that doesn’t sustain or enrich your life
- Optimize federal and state taxes
- Develop a credit card cash/points strategy
- Start a side hustle/small business focused on your passion(s)
- Have an investment withdrawal strategy
- Revisit and readjust as necessary
Determining what you want to do is a very personal choice and can vary widely between people and even between a single person as he or she ages. This blog makes no attempt to dream your dreams for you. However, having the dream firmly set in your mind gives focus and provides motivation to do what is necessary to achieve it.
What we will discuss is to go about planning a path to getting to that goal. For people who want to continue to work, at least part time, estimating how long and how much net earnings would be each year is a good first step. Assuming that this estimate closely approximates what would happen, one can leave the drudgery of 40+ hour work weeks and long commutes much earlier if she is willing to work a bit in the early years of rightirement. This also reduces the risk of poor investment returns in the early years after leaving the full-time work force.
The list above is flexible and can be tailored to fit one’s needs. For example, having a credit card strategy is not required to retire early, but it can get someone in the fast lane to achieving it by earning money back just for spending it. Maxing out retirement accounts is a foundation of financial independence in this blog and frankly, just about every personal financial media outlet or blog.
For those that are approaching Social Security full retirement age, it makes sense to get an accurate estimate from ssa.gov about their estimated monthly check. It generally makes sense to delay taking Social Security until age 70 if one is generally healthy, has good history of family longevity and has a sizable nest egg outside of Social Security. Knowing how much to expect to receive from Social Security will inform the rest of your rightirement planning.
Reducing expenses has been discussed here and here. Reducing expenses is the most powerful way to achieve early retirement, because it lowers the hurdle of monthly income required to sustain a lifestyle and also because it allows a greater percentage of income to be devoted to investing, getting one to financial independence faster. It’s also important to keep expenses as low as appropriate after rightirement. Make sure to factor in medical care expenses that might be currently covered by an employer.
It can’t be understated the powerful effect that reducing unnecessary spending has on reaching financial independence. Reducing monthly expenses by $100 equates to a Rightirement Number that is $30,000 lower using the 4% rule ($100 $/month x 12 months x 25). Rolling that $100/month into an investment account will be worth over $17,000 in 10 years at a 7% growth rate. Combined with the lowered threshold from reduced expenses, you’re $47,000 closer to your Rightirement Number just by starting out saving $100/month and investing it instead.
Estimating What You’ll Need
Once a reliable estimate is established regarding yearly expenses and yearly income, it’s time to figure out one’s Rightirement Number*. That Number is an approximation of how much is needed across investment accounts to continue the expected standard of living indefinitely. This calculation has been examined by many researchers, statisticians and early retirees. While there’s no final word on the exact “safe” value, most people tend to agree that a 3.5% to 4% withdrawal rate should be able to be sustained nearly indefinitely, provided that investment returns in the future are similar to those in the past. These assumptions includes different mixes of stocks and bonds and also allows increasing expenses each year to keep pace with inflation.
This will be discussed in more detail in a subsequent post, but for our purposes, we will assume a 4% withdrawal rate, plus a Social Security withdrawal at age 70 are sufficient to meet ones needs and thus would be financially independent. That is, for someone needing $30,000 per year in expenses, a nest egg totaling $750,000 would likely be sufficient to withdraw $30,000 the first year and more in subsequent years to maintain today’s purchasing power. For someone who is a little more conservative and wants to follow a 3.5% strategy, that Rightirement Number would be around $857,000. It’s important to note that these are just estimates based on historical data. Having a few thousand more or less than these numbers won’t statistically alter the outcome.
Minding the Tax Man
To turbocharge your savings, it literally pays to evaluate and optimize your tax situation. Legally paying a lower tax rate now allows more of your money to compound year after year. It also increases the percentage of income that can be devoted to investment rather than paying to Uncle Sam. Assuming that the above $100 monthly expense was previously taxed at 39% (25% federal and 7% state and 7% sales tax), and that money is now put in tax advantaged accounts, like an IRA or 401k, you’re actually putting in $139 per month or over $23,700 in ten years, instead of the $17,000 above. If you still have room in your HSA, you also don’t pay the social security or medicare taxes for another 7.65% less in payroll taxes ($25,000 in ten years).
Credit Card Turbocharger
As mentioned in previous posts, here and here, credit cards can be an excellent tool to reduce total money outlays as they provide rewards, often in the form of miles or points that can be converted to cash, gift cards or travel. While the number of card redemption strategies are legion, even a basic 2% cash back card would provide a reasonable return of cash for the uninitiated in credit card hacking. Fidelity offers a 2% cashback card with no annual fee. Capital One also offers similar cards for both business and personal albeit with an annual fee. In my experience, a 30-60 second call to Capital One has always reimbursed me for the annual fee.
Adding in a couple of new credit card applications per person per year can easily net $1000 per person in sign-up bonuses alone. For a couple, that would amount to $2000 per year in rewards for spending that would likely have happened with or without the credit card. These rewards are generally not taxable so they go that much further to provide income for both pre- and post-retirees. Additionally, many cards provide other benefits like free car rental insurance, price match protection, no international transaction fees, access to airport lounges, free hotel nights, etc.
Building Up a Side Hustle
When left to follow their own passions, people generally find out that there are people who are willing to pay them for some of what they love doing. Whether it’s surfing, working out, real estate, or even gaming, there is a market for people’s expertise. Identifying ways to generate income from your passions is one of the best ways to keep mind and body sharp while still having fun and getting paid.
Progressing down the road to financial independence is exciting, whether you’re just hearing about the idea or are already there or somewhere in between. Having some measure of financial security goes a long way to reduce stress due to financial burdens and allows one to do more strategic, long-term thinking rather than figure out how to get by for another day. Establishing the foundation provided by Dilbert’s creator will go a long way to reducing stress and worry related to financial issues. Adding in the extra stability of lowered expenses, lower taxes, credit card benefits and starting a side hustle provides additional power to speed up the rate at which one can pursue his or her dreams.
In part II of this post, we’ll discuss multiple strategies of accessing retirement money earlier than normal, planning for unexpected and the gorilla in the room: how do you retire early in the United States and still have access to health-care?
*Rightirement Number is just a rough estimate of what you’ll need to sustain current life style. Hitting this number will not magically change your life and while it can be a good rough estimate, its important to not get too hung up on just getting to that number.