Should I stop using retirement accounts if I’m planning to retire early?
Today’s question comes from Kenton. He asks:
I really appreciate you sharing your experiences about how you became FI.
I read this article: https://chrisreining.com/is-starting-a-business-the-fastest-path-to-financial-freedom/ — loved it. I’m 35, happily married with four kids, in a “typical” financial situation (ok salary, mortgage, credit card debt, small 401k).
How did I find you? Well, that’s a very personal discussion I’d like to share with you that leads up my question.
My grandfather died at the age of 57 of a heart attack. He was a poor farmer, never had much, and left my grandmother destitute.
My father died in January at the age of 65 of the same thing while on a bicycle ride. Lucky for him he saved, invested, and worked for a company that gave him a pension. He retired 2 years earlier and was able to enjoy FI for a short amount of time. I remember snow skiing with him last year. We were riding up the chair lift and he suddenly screamed out “I wish I could do this every day!” I thought he was crazy. He was loving life, loving retirement, and then BANG!
While at the mortuary deciding on which casket to put him in it hit me. My grandfather died at 57, and my dad died at 65. If I follow a similar path that means my life is past the half-way mark. I saw myself laying in that casket. I determined at that time that I would be a better husband, father, brother, son, friend, and human being. But a strong desire also ignited within me to figure out how I could achieve FI early so I can have more time to spend with my wife, children, and grandchildren helping them, helping others, and doing things that are meaningful to me.
When I got home from the funeral I immediately increased my life insurance policy so my family would be taken care of just in case, and started searching the internet for “financial independence”, “how to retire early”, “how much do I need to retire”. That’s when I found your site. Your experiences and insights have given me hope that one day I’ll reach FI and hopefully do it sooner than even my grandfather. You’ve been able to break it down into simple, understandable concepts.
But here’s my question. What kinds of investments should I get if my goal is early FI…like 50 years old? Do I even need to invest in a 401k (my company does do a pretty good match so I’d be giving that up but may not ever be able to use it)? Do I just put everything into a post-tax index fund account and build it up to my FI amount? Do I have a combination of both because who knows, maybe I’ll live til I’m 90 or they cure heart disease between now and then? What does the plan look like for people’s who’s goal is to achieve FI before 67? Where should I invest money into? I realize that additional income will be needed, so I am currently working on creating a side business that I hope to build up to replace my current income. Any extra from that will go toward the plan…so hopefully I can speed things up with that.
First of all, there isn’t a one-size-fits-all solution for financial independence and early retirement.
People successfully get there taking different approaches, so it’s more important you figure out which approach best fits you personally.
If your sole investment vehicle is the stock market then you need to figure out where best to put your money. Let’s take a look at your options.
1. 401(k) account
Most people are concerned they can’t access 401(k) money before age 59.5 without paying a penalty.
This is mostly true. However, if you retire at 55 the money you have in your 401(k) with your current employer is available without penalty. And if you’re a public safety government employee it’s 50.
If those things don’t apply to you, or you want to retire at 40, there is one option. You can take money out penalty free using what’s called a “series of substantially equal periodic payments”. This is also known as IRS rule 72(t).
You have to take these payments for five years, or until you reach 59.5, whichever comes later. Using this rule is complicated, so get help from a tax professional.
2. IRA account
Any money you contribute to a Roth IRA can be taken out at anytime without paying a penalty.
However, the earnings are treated differently. Generally speaking, you can’t access earnings prior to 59.5 without paying a penalty.
3. Taxable account
Any money you have in a taxable account can be taken out at anytime without penalty. The downside of a taxable account is that you might be paying double taxes.
Why?
First, you’re paying income tax on the money before you even invest it. And then after you sell an investment you pay a capital gains tax on any gains. This varies depending on how long you hold an investment and your tax bracket.
It’s difficult, but if you can keep yourself in the lowest tax brackets you won’t pay any capital gains on investments held for over a year.
As you can see, the right answer for how to invest for financial independence is “it depends.”
Maybe sharing what I did will help. I was investing in two places: a 401(k) and a taxable account.
I always contributed enough to the 401(k) to get the full company match, because not taking advantage of a match is like not bending down to pick up thousands of dollars off your kitchen floor.
After the 401(k) any extra money I had went into the taxable account.
When I quit my job at 37 and starting living off investments, 25% of money was in the 401(k) with the remaining 75% in the taxable account.
My thinking was that the taxable account would pay me for 25 years or so, and at that time the 401(k) — just sitting there compounding the whole time — would pay me for the next 25 years.
I didn’t want to monkey around with a gazillion different accounts, so this two-account approach seemed simple enough.
Make sense?
And it just so happens that the money in the taxable account will probably last forever. I overshot.
That’s okay, because the 401(k) serves as a backup in case of “spending shocks” or “lower future returns” or all the known unknowns people like to worry about.
Anyways, my own father was killed young, so I can relate to your story.
When you understand that you’re going to die — that everyone must die — it’s the best motivator to start living the life you want to live.
Try pretending for just a moment you’re at the end of your life and ask yourself, “What was important to me?”
You’re not going to say it was a bigger house, fancier car, more glamorous job, because you’re going to say things like family, relationships, happiness.
Align your life with what matters to your future self, and you’ll start living a more meaningful life, right now.