Last month, I came to the shocking revelation that I’m set for life.
Even if I never invest another cent, ever, all signs point towards me reaching age 60 with $1.5 to $2 million dollars. (That’s adjusted for inflation, meaning the portfolio in 2050 will buy the same amount of stuff as $1.5-2 million dollars today.)
As you might imagine, this little tidbit has my head spinning. Most Americans slave away at jobs they hate for decades, in hopes of maybe one day saving enough for retirement. Most never make it.
And here I am, still in my 20s, and I’ve already reached the goal driving so much stress for so much of the working population.
Which kind of raises the obvious question…
Most specifically, do I keep maxing out my 401k religiously? Even when its intended use is to prepare myself for a goal that I’ve already blown out of the water?
What to do with your money, when you’ve already saved “enough” for retirement
With enough money saved for a “normal” retirement, I see a few options for what to do with all the money I’ve saved each year to get here.
1) Spend it.
With my “normal” retirement fully funded, I could start spending the $18,500 a year I was previously contributing to my 401(k).
Actually, why stop there? If I was content working until age 60, I could also divert my $20,000 of after tax savings towards buying stuff.
With an extra ~$35,000 each year, I could:
- Quindecatuple (that’s 15x… I had to google it) my food budget, literally only eating at the most expensive chef tasting menus in the city every night.
- Move into an $900,000 mansion, and start living paycheck to paycheck while I dealt with the $3,000 a month mortgage.
- Lease this Lamborghini Gallardo for $1,700 a month, which would help show the world how successful I am.
Unfortunately, science shows (as does confessions from the world’s biggest spenders) that this is a pointless battle. Hedonic adaptation says this approach will become unfulfilling quickly, and I’ll find myself with a vicious standard to maintain my happiness.
On the other hand, I could take a more experience-based approach. With $35,000 to burn, I could take $3,000 vacations every month. I could buy last minute flights to just about anywhere in the world, and I could stay at pretty fancy hotels while I was there.
BUT, this approach would be nearly impossible to pull off, since vacation time is limited when you’re still tied to an intense full-time job. And even if I could get the time off, I’d still find myself faced with the depressing reality of going back to work every Monday.
In a way, this would be the ultimate false sense of security. I could have nearly anything I wanted, so long as I continued devoting my life to a career.
What good is all the money in the world, if you still don’t have your freedom?
Interestingly, this is the path the largest portion of the population takes.
2) Eliminate your extra income, by chasing a lower paying “dream job.”
With no need for the $35,000 of excess income I’ve been saving, I could walk away from my promising career in finance to pursue something less lucrative.
If my retirement saving is already finished, there’s no sense working a job that doesn’t cause my spirits to soar every Monday morning.
Since my post-tax living expenses are only around $20-24,000 per year, my target annual salary would be about $30,000 per year.
Only needing to earn $30,000 a year opens up a whole new world of possibilities. Nearly every job, from a grocery bagger earning $15 an hour to a line cook at that delicious Thai restaurant down the street, is now on my radar.
Freelance writers average about $25 an hour, so I could hang up the Excel spreadsheets in favor of Word documents, which is more in line with my passions anyway.
Then again, if we’re dreaming, why not get really crazy with it?
- I could pursue my dream of becoming a professional beer league softball player. I couldn’t believe it either, but those guys can earn $30-40K a year, although my talents might limit me on that one.
- Ski instructors can clear $30K a year. Talk about the ultimate dream job. Plus, I’d be getting paid for my most expensive hobby, which would lower my living expenses further.
- I could even explore whether this blog can grow big enough to support my frugal lifestyle.
The best part about this strategy?
When you work a dream job, holding on until age 60 isn’t a chore. Who needs to retire when you love your job?
The negatives, obviously, are a lack of options due to a lack of income. My living expenses might not stay $20,000 a year forever, especially if kids enter the picture.
And since I’m not 100% financially independent yet, I’d still “need” the job, and I’m pretty convinced dream jobs don’t exist whenever they’re mandatory. Even the best job gets old after 8 hours a day for years on end, and sometimes, you just want a day off. When that happens, the hobby starts to feel like work, and the dream slowly dies.
3) Stay the course, continue maxing my 401k, and take advantage of loopholes to retire in my 30s.
Now we’ve reached the “textbook” early retirement strategy.
Of course, the big asterisk with my recent accomplishment, and the big problem with the first two strategies, is that retiring at age 60 was never my goal. If you’re reading this site, it’s probably not yours either.
We’re all about fast tracking our freedom, which means totally walking away from a job if needed. In order to do this, we’ll probably need to access that 401(k) money long before age 60.
There’s a couple ways to do so, but the most commonly used hack by early retirement ninjas is the Roth IRA Conversion Ladder.
Here’s the cliff notes of that strategy:
- Continue maxing out your Traditional 401(k) every year. (And enjoy thousands in reduced taxes)
- Build up a small pool of taxable investments. (like Vanguard index funds)
- Retire at an age young enough to shock the world, living off your small pool of taxable investments while you…
- Rollover your Traditional 401(k) to a Traditional IRA. (This incurs no taxes or penalties, since the two accounts are functionally identical)
- Convert that Traditional IRA to a Roth IRA in increments equal to one year of your living expenses. (You’ll owe taxes on the amount converted at your ordinary income tax rate, but if you’re an early retiree living on peanuts, this could be as little as 0-15%.)
- Wait 5 years, then withdraw your living expenses from the Roth conversions, one year at a time, penalty free. (Thanks to an IRS rule on Traditional to Roth IRA conversion after 5 years.)
Justin at RootofGood.com has an excellent walk-through of how he used this strategy to retire in his 30s, and the Mad Fientist also has an excellent article explaining his approach.
This is the tried and true blueprint used by many of the internet’s most famous early retirees, and the Roth IRA Conversion Ladder has some serious advantages. If you’re racing to hit early retirement as fast as possible, this is probably your best bet.
For one, it’s far and away the most tax efficient early retirement strategy. As you continue to max out your 401k during your working years, you get those big tax savings today. Then, when you withdraw the funds in early retirement, your income sources are limited to the IRA conversions, which reduces your taxes owed, and in some cases, eliminates them completely.
That said, the Roth IRA Conversion Ladder isn’t perfect, for a few reasons:
- You’re locking yourself into a pretty frugal lifestyle for the rest of your life. Most early retirees have reached a Zen-like approach to money, where this doesn’t bother them in the slightest, but it’s obviously not for everyone.
- Ideally, you’re planning your expenses 5 years in advance. Changes to lifestyle or inflation rates could present issues.
- You’re exposing yourself to some regulatory risk. It’s extremely unlikely, but if the federal government ever closes this little-known loophole, you could be faced with a 10% penalty to access the 401k money you worked so hard to build.
A decent contender, but let’s keep exploring options.
4) Use savings to create a business
It’s no secret that all of the world’s richest folks are business owners. So, if you want to get filthy rich, the path is clear. Build a business!
$35,000 a year is more than enough to fund startup costs, build prototypes, invest in inventory, or run advertising for any number of entrepreneurial ideas.
The one big hiccup in this plan? This blog has taught me that even something as simple-looking as an online diary can require an insane amount of work, so I can’t even imagine how swamped real life entrepreneurs must be.
Not to mention, most entrepreneurs are motivated by a multi-million dollar company sale someday in the future. That level of effort may be overkill, since I’m aiming more for “pretty rich” rather than “filthy rich.”
And besides, trying to pull this off with a full time job and a full time blog? Might be a little ambitious for now. We’ll file it away under “post-early retirement goals.”
5) Divert the 401(k) contributions to taxable investments.
Did you know that you can earn up to $101,200 of dividend income as a married couple, without owing any taxes?
Well, that sounds like a goal worth working towards…
As of the most recent net worth update, I’ve saved $118,000 between my 401k and IRA. IF the market compounds at a normal historical rate over the next three decades, this amount SHOULD grow enough to cover ages 60+. ($1.03 million in today’s dollars assuming a 7% growth rate)
So with the retirement accounts out of the way, let’s see if I can build up a big enough portfolio fund my lifestyle from aged 37-60 using only tax free dividend income.
We’ll start with my brokerage accounts. So far, I’ve saved $111,000 in those.
Now let’s say I start adding my ~$35,000 of annual savings to the brokerage account. We’ll also assume I buy nothing but dividend paying stocks.
Fire up the financial calculator, and I’m looking at a $623,000 portfolio by age 37.
If that $623,000 provides a reasonable 4% dividend yield rate, I’d be earning $24,960 of tax free income every year. That’s like having a $30,000+ salary, just for having money in the market! Take that, cheap paying dream jobs.
The best part? Since I should have ages 60+ covered by the retirement accounts, I don’t need this portfolio to last forever.
The “4% withdrawal rule” measured success as not running out of money within a 30-year period. Since I’d be working with a 23 year period, there’s no shame in reaching age 59.5 with a few pennies left in the portfolio. From there, the retirement accounts and social security (ha! funny joke…) could take over.
To be fair, this is probably the riskiest option. A market crash at just the right time could do serious damage to this well laid plan, but it’s an interesting option nonetheless.
6) Use my annual savings to fund down payments on rental properties.
As the saying goes – invest in stocks for the appreciation, invest in real estate for the cash flow.
I’ve got the appreciation covered, as evidenced by my future portfolio values, which makes my early retirement plans a question of cash flow.
$35,000 a year would be enough for a down payment on at least one rental property a year. I’ve explained my approach for analyzing duplexes before, which I calculate can realistically provide around $2,000 a year in cash flow.
Build up a portfolio of a few rental properties over the next 10 years, and I could be looking at $20,000 of annual cash flow. ($50,000 per year when adding in the effect of equity building) Plus, this cash flow position should improve over time, since a property’s mortgage stays constant, while rental prices (hopefully!) increase.
Here’s a great example from Bigger Pockets showing how a normal family could build up $70,000 of annual cash flow in 10 years, just from steady real estate investment.
Real estate investment also carries tax advantages, so I wouldn’t lose all the tax advantages of my $18,500 of 401k contributions. When investing in real estate, depreciation and mortgage interest are tax deductible, which reduces your taxable income similar to 401k contributions.
Which Path Would You Take?
If you made it all the way to the end of this big post, congrats!
Unfortunately, I don’t have a nice, neat conclusion to reward you with. Putting this post together definitely helped me clear my thoughts, but I’m still weighing my options.
I do think I’ve reached a couple decisions though.
- I can safely say that spending all my money is out. That’d eat away at my frugal side, and blowing cash is the sign of a problem, not freedom.
- Chasing a lower paying career is probably out too. I’m just not enough of a free spirit to take this jump.
- Building a business sounds a little intimidating.
Which leaves a three-way tie between the Roth IRA Conversion Ladder, building a dividend portfolio, and investing in rental properties.
Right now, I’m leaning towards investing in rental properties. It would provide a level of diversification to my stock heavy portfolio, and the upside seems the highest of the three choices.
Plus, to be honest, owning rental property has always been a goal lingering in the back of my mind. I fear that if I don’t at least try out this landlord thing, I’ll always look back and wonder “what if?”
Readers, what do you think I should do with my savings moving forward? Which path would you take?
Interesting ideas on accessing funds early in retirement, but you forgot about Rule 72t. I am a fellow Twin cities resident who also works in finance. Well, incase you didn’t guess, I like to research my options. The Mad Fientist did a good comparison article on this subject.
I liked this idea, because of the tax advantages up front and the adjustment of the withdrawal amount on the back end.
Since we are both living here and enjoy a local brew, feel free to reply back, it would be fund to meet up. I am always looking for someone fun to share ideas with and learn new things from.
The Money Wizard says
Brian, thanks for pointing this out. Ive never been a big fan of the SEPP 72(t) distributions, since you basically have to decide for life how much you’re going to withdraw each year (with only one adjustment allowed). That lack of flexibility stresses me out, so I find the Roth ladder more appealing. Thanks for sharing another strategy though!
Larry Farrell says
I would suggest trying rental properties. That way you will not have everything tied up in the stock market and will be diversified more. Rental properties are not for everyone but if you want to put some sweat equity into them I think it would work out pretty good. I would stress to screen your tenants closely, we prefer to have a unit sit empty instead of getting the wrong tenant.
Just my two cents. Good luck and enjoy your blog.
I think it’s just a personal decision, right? You’re right about the diversification and potential high returns, but is it worth it for all the work you have to do? That depends on the individual.
I think I lean towards the stock investing approach, but maybe that will change. It seems like Sean would enjoy the hands-on work involved with renting.
The Money Wizard says
Definitely a personal decision IMO, but I appreciate the perspecives!
I definitely think you should go with the rental properties option. This would provide a good diversification on your portfolio.
Great read Money Wizard!
I’m a long-time reader (like 6 full weeks now) first time caller. I was drawn to your story because I’m in a very similar situation to yours, 27 year old married DINK with a healthy savings rate and aspirations for a financially independent future.
One difference I struggle with is that I live in the Bay Area, where $900k doesn’t get you a mansion in exchange for living paycheck to paycheck, it gets you a fixer upper.
Sticking with renting now, but I’ve been thinking a lot about how to deploy money outside of maxing out our 401(k)s. The goal is to be able to afford a home to live here, close to family, in about 5 years without it completely derailing our goal of financial independence.
Ideally we’d have cashflow from other properties + build up equity as a downpayment for that home when we’re ready to buy, looking for opportunity in either a market downturn or a fixer-upper.
The way you framed up these options really helps me organize my thinking, so thanks!
I’m attempting a hybrid of #6, #3, and #5, in that order.
#6- After 2 years of reading up on real estate investing, listening to Biggerpockets podcasts, and saving up for a downpayment I should close on my first out of state multifamily property (11 units) at the end of this month with a couple of partners. It’s not going to a huge deal, but it’ll cashflow from day 1 and the stuff we’re learning is phenomenal! Our goal is to buy one multi-family per year over the next 5 years, pursuing solid cashflow and rolling the cashflow from one deal into the next.
#3- While that happens, the set it and forget it benefit of 401k investing is pretty appealing, and it’s a low risk low maintenance way to build wealth, so we’ll keep working to max those out.
#5- Any additional cashflow from our lives and properties will be set aside in a 60-40 mix of low-cost mutual funds in a taxable account, ready to be deployed when the next real estate deal comes along, or to chill out and grow for a downpayment on a home in ~5 years.
On a side note, and this is certainly overstepping for my first comment, but I highly recommend marriage :). People talk about it like it’s this major impediment to financial independence. I’ve found it to be the opposite.
Partnering with someone who is aligned to these goals and combining finances has definitely supercharged our progress. I look forward to seeing how you and MMW tying the knot both simplifies and strengthens your financial situation.
The Money Wizard says
Thanks for sharing your strategy Jeff. Glad to have you reading along, and keep me updated on your real estate progress!
I’m in a similar boat and considering the rental property route. It encourages you to learn about your city and neighborhood (love where you live), and you will learn a lot of valuable skills that will help you earn sweat equity. MMM knows a lot about construction, and has said how working on homes gives him an outlet to keep trying new things to avoid hedonic adaptation. Seems like a good deal. The problem for me is that rental properties in my area are expensive, and seem to have the rental income priced into the home’s selling price. I want to buy a large house and convert it to a duplex (this is what my current landlord did) but I don’t have the know-how to do this. I’m thinking about teaming up with a friend of mine who already has a couple of rental properties and being co-investors. MMM did this in the past though and had some relationships turn sour so I’m not sure if I want to get tied up with someone else.
The Money Wizard says
Prices in my immediate area have gotten a little more expensive than what I’m comfortable with too. I’ve expanded my search to a couple hour radius and am considering a property management company, but this makes me nervous as a first timer.
Just a thought for you to ponder is that another rental aspect to look at are leasing industrial buildings. I’m currently leasing a building my husband and I built and ran our company in for 27 years. He passed away last year so I am now leasing the building to my current employer. Since I still need to work to recoup some of the savings we had in keeping my husband alive during his cancer battle, this gave me the best of both worlds…..a job (I sold our company for a pittance to my current employer) and rental income to make-up for the loss of my husband’s SS and income from our business. I am now able to save for my future retirement and will still have the monthly lease payments upon my retirement.
The Money Wizard says
Sorry to hear about your husband.
Kudos to you for taking charge of your finances though. Sounds like you’re rocking it. Thanks for sharing the interesting strategy.
Very sorry to hear about your husband. Your situation shows why I won’t quit working despite having a lot of money saved- you never, NEVER know what life will throw at you later on. We’ve dealt with expensive health issues, natural disasters, market downturns… I won’t quit my job (which I happen to love, thankfully) until my last kid is out of school.
Thank you Jeanne. Life does throw you curves. I feel blessed to be in the position I currently find myself as expensive health issues, market downturns, etc. could have put us under as a couple let alone my being a widow today. My husband and I have always been frugal so that has helped tremendously too. That being said, I’d still prefer to have my husband alive than being alone today. Treasure what you have while you have it and enjoy the ride of life!
Question on #5. How are you getting tax-free dividends? I earned some dividends from my brokerage account last year and they had to be reported on my 1040 and counted towards my yearly income. Thanks!
Same question…confused by these. I believed it would be tax free in a Roth only.
The Money Wizard says
You owed taxes on them because you earned enough total income to put yourself in at least the 25% tax bracket. As long as you stay in the 10-15% tax bracket (10-12% with the new tax act) the dividend tax rate falls from 15% to 0%.
A couple of articles you might like:
I can’t tell you what you should do, but I can tell you what we’re doing. We are continuing to max out our 401K/403b/457/backdoor IRA space.
Why? Mainly college financial aid purposes. Our income is on the border for private 4 year schools so how much money we have in taxable compared to retirement tips us into different “no aid/some aid” bins, particularly if DH’s job disappears at college time. Not that I don’t believe in giving colleges money, but some of these places have attendance costs of over $70K/year.
Also some because I don’t know what else to do with it. And because if we do decide we want to move to Silicon Valley then we can stop saving for retirement and funnel it into a house downpayment at that point. While we don’t know what else to do with the money, retirement saving is as good as any, especially since we can always tap the Roth IRA principal in an emergency. (We also have 457 savings that could be tapped in an emergency, but is currently in the retirement savings bucket.)
Personally I can not think of much less in the world I would rather do than deal with rentals. Give me a diversified portfolio of genuinely passive investments any day.
Saver Steph says
What I’d personally do:
-Continue maxing out 401(K) until 2020 and/or age 30 (which ever you prefer)
-Starting in 2020 (or once you reach 30) start systematically scaling back contributions to a $5-8,000 year contribution until retirement. (or earlier)
-If I remember correctly you like to run a little lean on actual cash reserves, but I’d be building this up as well in general cash + maybe a CD ladder for about a $30K buffer.
-Then with the leftover start saving cash for a rental property by the time you decide to retire. By then you’ll definitely have a good down payment or even enough for a cash offer?
-If there’s anything left over then the rest I’d be saving/investing in a brokerage/robo-advised account. Even if it’s just another $100 or so amount just to get that dollar cost averaging and hopefully have a little more growth than the bank.
My only concern is being overwhelmed by rental properties while I still have a full-time job. Unless I’d be able to have some type of property management I was working with, I honestly couldn’t see myself fielding calls about a broken water pipe or any other repairs during my normal work day, and just wouldn’t want that extra stress at that time. I rather just keep saving/investing til my last day and go out “at the top of my game” so to speak than already getting burned out with too much on my plate. This may be a short sighted view but, I always try to consider my own personal well being/state of mind when considering big changes.
One question I have, don’t know if you’ve brought it up or not, but being from Texas then living in Colorado and now living in Minnesota, do you see yourself staying put? Or would there every be a chance of you moving again? Just a thought I had.
If you have some good handyman skills and the time to actively manage them, rental properties can be great. Just be sure to consult with a good lawyer about how to hold title to the properties (ideally a separate LLP or LLC for each one) and a good insurance broker about how to protect your personal wealth in case anything goes wildly wrong at a property. Otherwise, REITs can be a way to get real estate investment income without the personal involvement.
matthew hogan says
Rental properties. Just be sure to continue writing this blog. You are the most entertaining and enjoyable to read financial writer in the history of financial writing! Thanks
Festus Hagan says
Having read your blog for over a year I am impressed with your analytical abilities and what you have achieved – you are to be congratulated!
I have been fortunate to have been given enough to retire on but at 63, running several businesses, I have no desire to do so.
I love my work and every day presents new challenges.
I spent 9+ years running a remodeling company, became a property manager and now I make loans to small investors who rehab houses.
So I don’t have to swing a hammer, make 10%+ return, get to continue to run a property management business and enjoy seeing my investors become successful.
Rental property is 24/7 and just when you think you have everything under control, well, you know the rest of the sentence!
If you are going to go that route, rental properties, have a good handyman available (or become one yourself), understand how people who are renters think and act, and fix all problems immediately, if you want to keep your tenants.
Any money you place in your 401-k today saves you taxes. I’m not sure what your gross annual 8ncome is, but take this into consideration before ceasing your contributions. At the very least, invest up to the company match. Otherwise your pissing away the opportunity for free money.
As for your other options, pick #5. I’m in that boat and ai can attest that having a large taxable account provides liquidity and peace of mind.
I have only 10% of my assets in tax deferred accounts (401k & IRA). 90% (approx. $1.7 million) is taxable. I’ll retire in 4 years at age 55 and I’ll draw from the passive income in my taxables, allowing my tax deferred accounts to keep growing. You should consider this also as an alternative to all that Roth conversion mess and all the complexities associated with it.
[email protected] says
Wonderful post. I’d need to know way more to tell you what to do. The 401(k) vs. taxable should be based on tax rates. Real estate can be a good option if you have the knowledge or desire to run it. Remember that it’s not passive. I’m in a similar boat and a few years further along so maybe my plan can help you.
I’m actively looking into becoming a financial advisor which is a life goal. It will be a lower paying job than I have now. I plan to find a way to do it part time one day, “retire” to the mountains and may use the extra time to become a ski instructor.
I agree with those who don’t want to get called at midnight about overflowing toilets- and from my experience property management companies really cut into profits. Though if you can break even, at the end you have an asset that someone else paid for…
You don’t mention HSAs as another option for tax free savings- what is your thinking on those?
You also don’t mention philanthropy – another option for extra money!
We’re financial backers in 2 small businesses- risky for sure, but have the added value of improving the economy and services of our little community.
Hi Wizard, great post. I’m in similar situation where I need to boost my cash flow for my 40s and 50s as I’m also already set for post 60s.
I’ve entertained rental property idea for a few years. But I hate dealing with the house issues I live in. Then I learned about dividend growth investing. I’ve created a “dividend machine” My portfolio yields about 3.5% on average and grows about 7% annually. So I apply the rule of 72 on the dividend portion only since I don’t really care about porrrfolio growth on this particular portfolio as long as dividends don’t get cut. I stick with blue chip stocks with reliable dividend increase history (who didn’t lowe it in 2008) that trades at under 20x earnings. I feel I could get it up to 40k a year in divvys that will continue to double every 10 years or so after I stop reinvesting. I have no intention of selling anything ever so I snooze through market corrections.
Anyway I felt the option #5 was a little under stated. The best part is my dividend machine won’t need a new roof or call me at midnight. The best part is I get 100 free trades per month so I can lower my cost basis whenever I want. I argue that this is probably the safest and most lucrative option that can be passed down for generations with step up in cost basis. I think this acts as my safety net as most of my ETFs and MFs are fairly aggressive. But hopefully I will never have to use 4% rule on those if I redirect my attention to this from retirement accounts. The only con is, it definitely takes time and patience. But you can set yourself up for 7-10% raises for doing absolutely nothing every year!
Mr. Tako says
Well, I vote for #5 because that’s pretty much what I did. At some point, after maxing out my allowed pre-tax contributions I still had plenty of cash around.
So I invested it in a post-tax portfolio… which has now grown to a couple millions of dollars. Sure, the pre-tax portfolio has grown too but the real “eureka” moment happened when I realized my post-tax portfolio was earning more in a year than I did at my job.
It’s a pretty amazing moment when you realize it.