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.)
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?