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You want to become financially independent. Who wouldn’t?
Financial independence (FI) is a life status everyone should strive to achieve, no matter how content one might be with work and at home life. The freedom to live without the constraints of paycheck-dependence is a pinnacle I’d like everyone to experience.
It’s tough to know where to start, though, and inertia will fight to maintain your status quo. However, once you get that boulder rolling, FI is practically inevitable. Have you ever tried to stop a boulder from rolling downhill? I don’t recommend it!
There is no one simple trick to get you from intrigued today to FI tomorrow (unless you’re 99.997% of the way to your FI goal today), but I can give you some quick tips that can be the nudge that gets your FI boulder rolling in the right direction.
#1 Max Out All Available Retirement Accounts
If you aren’t automatically maxing out all available tax-advantaged retirement accounts, this is a great place to start. To do so, you’ll need to know three things.
- What accounts do I have available?
- How much can I (or we) put into each account?
- How can I automate the process?
The answers to the questions will vary somewhat from person to person, but the process of discovery should not be too difficult.
Tax-Advantaged Retirement Accounts
Many employees will have access to either a 401(k) or 403(b). Another possibility is a 401(a), which is often the landing place for employer contributions in a matching or profit-sharing arrangement.
A 457(b) account is often available to highly-compensated employees, as well. These come in governmental and non-governmental varieties. The governmental 457(b) is more flexible (can be rolled over into an IRA) and safer (backed by government solvency rather than an individual corporate entity).
However, if your employer is on solid financial ground, a non-governmental 457(b) may also be worth maxing out, especially if you have flexible withdrawal options (i.e. not a lump sum). You can withdraw this money at any age when you leave your employer. I started collecting mine in 2021 at a monthly rate that will likely deplete the account in early 2025.
You’ll be able to contribute $22,500 apiece to both the 401(k) or 403(b) and 457(b) as an employee in 2023. With employer contributions, the total can be as much as $66,000 in the 401(k) or 403(b). If you’re 50 or older, add $7,500 to those numbers.
An often overlooked retirement account is the HSA. You get a tax deduction on money contributed, the account grows tax-free, and when withdrawn to pay for eligible healthcare costs, it is not taxed on the back end. That’s triple tax-free.
In 2023, a family can contribute $7,750 to an HSA. The max for singles is $3,850. Don’t forget to invest the money once it’s in the account; most people mistakenly leave it in cash.
Roth IRA
Many readers of this blog will earn “too much” to qualify for direct Roth IRA contributions. Fear not; that’s why we have the backdoor Roth.
In 2021, as in the past couple of years, you can put $6,500 into a Roth IRA or $7,500 if you’re at least 50 years old. Don’t forget to contribute on your spouse’s behalf, also, even if he or she doesn’t have earned income. Now, you’re up to $13,000 to $15,000 of annual Roth contributions.
Note that this is not done in lieu of tax-deferred investing. In this case, the alternative is investing in a taxable account. More on that below.
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Self-Employed Accounts
If you are self-employed, an individual 401(k) is generally superior to a SEP IRA. If you are part of a small practice, you may have only the option of a SEP IRA or SIMPLE IRA. The limit for contributions on the SIMPLE IRA is $13,500 in 2021. Both an individual 401(k) and SEP IRA have limits of $58,000 in 2021 if your earnings support such a contribution.
Cash balance plans or defined contribution plans, are another option for the self-employed and small business crowd. As you get older, the contribution limits increase, and you may be able to shelter a six-figure sum from income tax in your later years as a working professional.
How Can I Automate Retirement Account Contributions?
Don’t ask me; that’s what your human resources department is for.
If you don’t like talking to those people or don’t know where to find them, you can probably set up most of the contributions via your plans’ websites.
Even if you think you are set up for maximum contributions, go ahead and log into your account for your 401(k), HSA, or any other accounts available to you.
Ensure that the amount you’re periodically contributing will indeed lead to a maximum contribution by the end of the year. Pro tip: Rather than contributing a percentage of your paycheck, contribute a dollar amount that will guarantee you will hit your savings goal, even if your income changes.
Automation is a key component of a great savings rate. It’s tough to spend money that never hits your bank account, and you’re less likely to miss that money when it’s destination is pre-determined.
For a more thorough walk-through of these plans and more, please review my two-part Investing Basics series.
#2 Start a Taxable Brokerage Account
A common sentiment I see expressed is “I’ve maxed my retirement savings. What should I do next?” This is often followed by a question about a recommendation by a “financial advisor” to invest in an annuity or cash value life insurance product of some sort.
The problem with such a question is that it’s not possible to max out your retirement savings. You can invest an infinite amount in a taxable brokerage account. Once tax-advantaged accounts are maxed out, just start buying more mutual funds or whatever it is that you’re into, outside of the tax-advantaged accounts.
A “taxable” brokerage account can actually be very tax-efficient and under the right circumstances, can be nearly as good or even better than a Roth IRA.
If you want to look outside of stocks and bonds, crowdfunded real estate can be a hands-off way to diversify into real estate. I own a couple acres of farmland via AcreTrader and have made several other equity and debt deals via different platforms.
If you’re willing to get your hands dirty, direct ownership of real estate is another option.
The bottom line is that just because you’ve maxed out tax-advantaged options does not mean you’re done investing for the year. If you earn a high income and want to save and invest half of your takehome pay to reach FI quickly, you’re going to be investing outside of traditional retirement accounts.
The beauty of these taxable investments is that there are no age limits or other restrictions. The money is there to use whenever and however you see fit. More than half of our retirement savings is in taxable investments.
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#3 Plan to Eliminate Debt
I don’t know a single grown-up who hasn’t held some debt at some point, and an overwhelming majority of us will be in debt to some entity for most of our adult lives.
If you’ve got consumer debt, think credit card or store card debt, for crying out loud, take care of that right away. No taxable account for you. Invest enough to get your 401(k) match and put everything toward that (usually) high interest debt. Consider a 0% APR credit card if you can’t tackle it right away.
Mortgage debt is not an emergency by any means, but you probably don’t want to have it forever. With the recent fed rate cut, mortgage rates are very low now, too, and it may be worth looking into refinancing to save some money and/or shorten your time to being debt-free.
15 year mortgage rates are typically lower than 30 year rates, and an adjustable rate mortgage (ARM) can be even lower, which might make sense if you plan to pay the loan off over five to seven years. If you’re looking for a traditional or physician mortgage loan, I’ve compiled a list of lenders to help you out in this regard.
It’s easy to treat student loan debt like a mortgage, and there are payment plans that will have you paying interest for decades. Unless you consolidated back when you could rates of 2% or better, don’t fall for that trap!
Your best bet to eliminate student loan debt is usually one of two options. Either pursue Public Service Loan Forgiveness (PSLF) while paying the lowest amount possible for ten years or refinance to the lowest rate possible and pay them off in under a decade.
Student Loan Refinancing Disclosures
Occasionally, the best solution is a third option that’s beyond the scope of this article, but there are options for taxable loan forgiveness after 20 or 25 years. In complex scenarios, I think a consult with services like Student Loan Planner or Student Loan Advice will more than pay for itself.
To check the latest refinancing rates from top companies and cash back offers worth hundreds of dollars, see our rate sheet on the Student Loan Resource Page.
It’s not paramount to be 100% debt free when financially independent, but being debt-free is a tremendous feeling that may well be worth missing out on some interest rate arbitrage opportunities that carrying debt can offer.
#4 Eliminate Wasteful Spending
Now that you’ve got a plan to eliminate debt, let’s eliminate pointless spending.
This is clearly a very subjective area, but it’s amazing how the things we spend money on and the things that make us most happy are often misaligned.
Realizing that we can be truly happy by being frugal in some areas, while still spending extravagantly on the things we truly love, can be life-changing.
Lowering your monthly and yearly expenditures has a dual effect that will have you racing towards FI.
First, your FI target is lower. Dropping your spending by 25% also lowers your nest egg or passive income needs by an equal amount. That’s a quick way to shave off a mid-six figure to low 7-figure dollar amount from your target.
Furthermore, the dollars you don’t spend will be invested instead and you’ll be setting aside more for your future every year. Now, you can buy that first rental property or start that taxable account that we talked about above.
Where do you cut? Most of our money is spent on housing, transportation (autos), food, and travel. Bigger isn’t always better, and luxury only speeds up that hedonic treadmill, which can be awfully tough to slow down once it’s cranked up to ludicrous speed.
You can also make incremental improvements by switching to a lower cost cell phone plan (I use Google FI for the worldwide coverage) or having your utility bills negotiated lower with a service like Trim.
Cutting the cord is another easy win. Many streaming services cost a fraction of cable or dish-based television providers.
Recognize that above a certain threshold, additional spending gives you rapidly diminishing returns in terms of happiness and utility, and you’ll reach FI much more quickly.
#5 Insure Your Income
If you fail to insure your income, you could take one step forward and two steps back on your path to FI.
Insurance income comes in two forms: life insurance and disability insurance.
Hopefully, you’ve already taken care of these, but if not, this is something you can line up today.
The only form of life insurance that I would recommend for 99% of the populace is term life insurance, and if no one is depending on your future income, you don’t actually need it at all.
If, however, you’re in a serious relationship, married, or have children, the responsible thing to do is to have enough term life insurance to make your surviving loved ones are financially independent in your absence.
Term life can be found at a very low cost, and companies like PolicyGenius will compare rates and give you the best deal out there in just a few minutes of entering your information online. I made a step-by-step tutorial here.
Disability insurance should not be considered optional until you’ve reached financial independence yourself. Even if no one else depends on your income, if you’re unable to work but still living, YOU will be dependent upon your income, so you really need to insure it.
Physicians make numerous mistakes when it comes to disability insurance. Look to a trusted independent agent to get you a policy that will cover you for your own occupation and specialty (hint: most Association plans don’t).
There you have it! Five action items that you can quickly implement to shorten your path to financial independence today. It is a long road, but if you know the shortcuts, and there are many, you can take years off of your FI timeline.
What one thing would you recommend to hasten the time to FI? Which of these have you already implemented? How?
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25 thoughts on “Top 5 Ways to Start on the Path to Financial Independence”
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Thanks for another great post! Item number 1 to max out tax advantaged accounts had created a tax time-bomb concern for us. With a high net worth we’re concerned about managing future RMD’s. We believe tax rates will be higher in the future so we’re topping the 24% tax bracket with both Roth conversions and withdrawals. We will have to temper that at age 63 to not inflate our Medicare premiums. If I knew this at a younger age, I would have been more aggressive with Roth conversions and saving more into a traditional brokerage account and/or other asset groups.
When you have an 8-figure tax-deferred balance (or mid-7-figure if single or widowed), RMDs can push you into those upper income tax brackets, and doing Roth conversions early on can help mitigate the issue.
It may be worth paying a bit more for Medicare (via IRMAA) if continuing to fill the 24% bracket will keep you out of the 35% or 37% tax brackets later on.
Qualified Charitable Distributions (QCDs) of $100,000 per person annually (and soon to be indexed to inflation) are another way to deal with the tax bomb that RMDs can be.
Cheers!
-PoF
One small mistake above regarding SEP IRAs. You say the maximum is $13,500. It’s actually $57,000, or 25% of compensation. Big and important difference.
The $13,500 was in reference to the SIMPLE IRA, and that number is correct.
The max for both the individual 401(k) or SEP IRA is actually $58,000 in 2021, and I’ve updated the post to add that.
Best,
-PoF
These are great reminders for anyone in the FI community and is a great starting place for anyone looking to get started. We plan to max my 401(k) for the first time ever this year and are going to try to max out IRAs as well. Next year my work place is adding an HSA options so I’m trying to learn all I can. If there’s any extra money left over we are stashing money to buy a rental property at some point (Chad Carson’s book is great)! Thanks again for the helpful tips.
PoF,
Do you have any first hand experience or recommendation, one way or another, on Fundrise?
Thank you,
Gino
If I’m interested in purchasing turnkey properties, is Coach Carson’s course still useful or is it more for people who want to more actively manage their properties?
Hi, I would say yes the course is still very relevant if you are purchasing turnkey properties. One of the dangers of the turnkey model is that you’re dependent on the research, recommendations, and advice of the turnkey operator – who happens to have a conflict of interest profiting from the property they are selling you. That doesn’t mean you can’t find good deals that way, but my advice is to build your own process of evaluating the market, the numbers, the property itself, and the management company in order to decide if the turnkey opportunity makes sense for you. All of that process is the essence of the course.
If you had told me you want to buy crowdfunding real estate or limited partnership syndications, I would not have advised you to take the course. Those are related but a slightly different model. Direct property ownership – whether turnkey or not – is more my focus.
Thanks for your interest and question.
I too paid off my mortgage (in 14 yrs vs 30) and it was a great feeling. My farm was harder to refinance than a conventional home due to the acreage. I tried in 2012, but the lenders were not interested because they were still reeling from all the Great Recession foreclosures. Therefore it made sense to me to prepay the mortgage I had and save the 6.25% interest, especially once the interest paid dropped me below the point of being able to itemize deductions. I did always focus on maxing out tax advantaged retirement accounts.
Congratulations on being 100% debt free!
I just read an interesting article at FI Physician where carrying a mortgage into retirement can actually be a protector of SORR. Personally I paid off my mortgage and have been happy to do so (and would do it again) but it is nice to always see contrarian viewpoints to see what best applies in your particular situation.