Family, children, and travel. The simple things in my head that made me consider the idea of working towards financial independence at an early age. The idea of retirement is pretty simple to me- getting to the point where I no longer need to work a mandatory job to cover our family’s expenses (ever again). Will we continue to be active and productive after we complete our mandatory employment? Sure. Idleness in not the end goal, choice is. I enjoy my current employment and lifestyle, but there are certainly a few tweaks I would make if money was of no concern.
Have you ever considered becoming financially independent at an early age? What would be a good target? 30, 40, 50? Have you ever stopped to consider what it would be like if you never had to work for an income again? Any changes you would make? I would love to have a little more time in my days. The primary motivations for me are: time with my family, financial simplicity, and a lifestyle of minimal environmental impact. Joe Dominguez and Vicki Robin have been writing about this type of financial lifestyle for over thirty years since the original publication of Your Money or Your Life in 1992.
What is the Point?
To begin, why would an individual want to retire after only working in the marketplace for ten to twenty years? It is a question that is being asked by millions of generation X and Y workers who are still at the beginning of their long-term career goals. After the recession, a major housing collapse, and high unemployment- security and the desire to be well positioned financially have driven many young individuals to think outside the traditional confines of retirement. In addition, there is also growing push back from watching baby boomers living out the ‘American dream’ by working a growing number of hours to buy more, often at the expense of their own health or time spent with loved ones. For the well-educated, the opportunities are uniquely present (historically low housing prices, interest rates, technological breakthroughs, and entrepreneurial opportunities) to retire at an extremely early age.
Who Are The Early Retirees?
Most candidates for early retirement tend to be young, self-motivated, educated, and (often) have an entrepreneurial spirit. Just from my limited workings with the primary demographic, many tend to come from an engineering mindset with overall efficiency and simplicity as overarching lifestyle factors. The income side of the equation is often the easiest part for most early retirees. The greater challenge is managing lifestyle inflation and the mass commercialization of society. Many early retirees are driven by a greater goal. The most popular include spending more time with family/children, traveling the world, missions/missionary pursuits, or the risk flexibility of pursuing entrepreneurial opportunities.
Making The System Work
From a logistical perspective, the government has heavily incentivized working until the traditional age of retirement at 59.5. Most workplace defined contribution plans have penalties built in for distributions before the traditional retirement age. In addition, the largest retirement income supplement, Social Security, would not be available for over twenty years for someone who retired today at age forty. The basic principles that need to be addressed for early retirees are simple: How to generate income in retirement and how much do I need to retire? In addition, it is important for individuals to understand what their lifestyle will look like after they are no longer tied to work.
Income Streams for Early Retirees
There are several classes of assets that work very well for individuals who are planning to retire well before the traditional age of American retirement. Paid for real estate (rental income), Roth IRAs, taxable brokerage accounts, dividend stocks, health savings accounts, and term/variable annuities are all popular investment options for non-traditional retirees. In addition to determining an asset allocation, finding asset classes that track inflation is also another obstacle for full-scale availability. When the time line is very long, inflation adjustments are extremely important.
However, the biggest challenge for early retirees is developing an efficient lifestyle, and curbing lifestyle inflation that typically comes with growth in income. For many individuals, as income rises there is an increasing propensity to consume. Decoupling consumption from income is a key tenet to both individual happiness and also sustainable retirement.
Having a paid for house is an efficient way to provide a risk free rate of return equivalent to the forgone outflow of a mortgage payment. Although some financial counselors would suggest a financially optimal plan of investing money instead of paying a low rate mortgage payment, having no mortgage payment outflow has huge implications on the cash flow of a individual. The equivalent risk-free rate of return rarely exceeds the rate of mortgage interest payments. In many cases, to provide a risk free annuity payment in preretirement equivalent to a mortgage payment would be more expensive than simply paying off the house. Reducing committed cash outflow also reduces income risk for early retirees by lowering the total income needs for a baseline set of living expenses. For these reasons, many individuals who desire to retire early will choose to live mortgage free.
Rental real estate is also one of the most popular cash flow producing investment options for people under the age of 60. Many early retirees invest in 1-3 properties in nice areas with high income, long term clients. In our home town, the $80,000 rental property we own will produce $10,800 in annual rent, including inflation adjustments. Just a few properties of this type would be sufficient to cover our lifestyle needs. During retirement, a property manager could be used to reduce the time, stress, and commitment of the properties with a marginal added costs. Roth IRAs have the unique capability of tax free distributions of contribution amounts at any time throughout preretirement. They often serve as a safety net and have liquidity options when specific chunks of cash are needed for distribution. Taxable brokerage accounts can also be used for structured distributions. A popular tool for early retirees using taxable brokerage accounts are automated tax-loss-harvesting. Staggered IRA conversion ladders can also be useful.
Term annuities and variable annuities are popularly sold in the financial world. Although, often over-prescribed and laden with high fees and commissions, the underlying products can actually be decent. Most annuities are pretty bad, but there are a few that are actually pretty acceptable, transparent, and effective for a baseline of guaranteed income. They can be useful, but most early retirees have more attractive options and more flexibility to make changes before resorting to the expense of guaranteed returns baked into traditional annuity products.
The beauty of early retirement, especially if an individual has little need for high income and a a low expense lifestyle, is minimal taxation. When one removes the outstanding payment outflow (house, car, tuition) often very little income is needed to live a simplistic lifestyle. The average family income of 51k a year would produce almost the same amount of disposable income of an individual living efficiently with no debt, minimal liabilities and an income of 25k. For an average family with a house payment ($1,061) and two average cars ($461 x 2) would require earning (23k + 25% tax, 6% tax, 7% payroll tax) or approximately $38,000 according to RealtorMag. By simply driving paid for cars and owning your own home could produce a similar disposable income to making 20k vs. earning 51k with average American payments. There are extreme tax advantages of having a very low income. If you are able to live comfortably off $20,000 with absolutely no payments of any kind, you land in a favorable tax and credit bracket. Also, once you stop taking income in the form of a W-2 and are living off pre-tax defined compensation, you can take advantage of the low tax rates using IRA rollover conversions with minimal tax consequence.
Finally, for individuals who are diligent and future orientated enough to build and plan and execute to achieve early retirement, they will find it very difficult not to earn any money after quitting a traditional employer. The super efficient subset of early retirees is often very good at generating income and being useful with all of their resources. During the accumulation phase, an early retirees may save 40-80% of their income. If they are making 100k and living on 20k, the accumulation for independence is very quick. In addition, it is very easy for well-educated individuals to unintentionally make 10k throughout retirement just by occasionally doing things they love. Many early retirees end up supplementing their retirement income by taking occasional projects that partially provide income. If one expects to live on 20k, then earning just a thousand a month would dramatically decrease the amount of nest egg needed for financial freedom. For example, I really enjoy bicycles and I’m sure I will continue to buy and fix up bikes to sell for the rest of my life. I simply enjoy the process, but the byproduct happens to be a few hundred dollars a month.
The ability to retire early is an exciting predicament. It is pretty incredible that we can take a few steps now to be the place we want 5,10 or 20 years from now. Financial freedom is a goal worth obtaining. I plan on spending lots of time with my family, children and traveling the world. I’m sure I’ll continue to make some money after I finish my compulsory employment, but I’m looking forward to all the different options available after financial independence.