How to retire way earlier in 10 minutes

This is the first post in a series of easy steps I’m writing for the New Year that will dramatically improve your financial security in 15 minutes or less.

Retire way earlier by boosting your retirement contributions in 10 minutes

Log into your employer’s retirement plan (e.g.: 401k/403b) and increase your contribution to 20%. Or, just put in the full IRS-allowed max of $19,500 for 2021. Divide $19,500 into your base salary to get a percentage.

Contributing 20% will only reduce your take-home by 15%-ish, depending on your tax bracket, because of the taxes you’ll save. If you were already contributing 10% to your 401k, an extra 10% will only cost you 7-8%. You can live off 93% of your old spending without even noticing, I promise!

If 20% is more than you can stomach to do right now based on your current spending, just log on and boost your contributions by 2-3% instead, which you definitely not miss since that’s a mere 1.5 – 2.5% of your take-home. After upping your contribution, set a goal of getting to 20% eventually, and use the automatic increase function that most providers offer to boost your savings annually by 2% until you get to 20% (or the max contribution limit.)

No matter how much you decide to contribute, definitely put in enough to get all of any employer matching your company offers. That’s free money you can’t afford to pass up.

Why boost your retirement contributions?

In addition to saving thousands a year in taxes, boosting your 401k contribution from 10% to 15% per year means you will have 50% more money at retirement.

Yes, that’s right, for the price of only a ~3.5% decrease in stuff-you-could-buy-that-you-didn’t-need-anyway, your income in your golden years will go up by 50%! Even a mere 2% boost from 10 to 12% ups your retirement income by 20%, so at least do that much.

I’d take this deal any day; wouldn’t you…? If you’re still not convinced that saving for your future is something you must do now, picture yourself in your 60s or 70s: grey hair– or white, if yours is already grey–, (more) wrinkles, a slower step, and someone wiser, quieter, but a little more lonely and less lively than you are now. Don’t you want that person– you— to be financially comfortable, maybe even relatively wealthy, even if it means a small sacrifice on the younger you?

Do it right now, before you read any further!

Log into your workplace’s retirement account, which for most people is either a 401k or 403b plan. Search your company’s benefits site if you don’t know where to go, or if you know they use Vanguard or Fidelity, head straight there and login (create an online login if you’ve never logged in before.)

Click on your 401k or 403b account if you have multiple accounts, and then look for something that says ‘contributions’ like ‘change my contributions’. Click that, and find your current contribution, usually expressed as a percentage of your base salary. Enter the new number that you decided upon above, and save your work. You should get some kind of confirmation screen.

Great work! Keep reading. You need to do one more thing while you’re logged in.

Optimize your investments with a few more button clicks

Switch both your current investments as well as your future contributions to a low-fee Target Retirement fund like those offered by Vanguard or the Fidelity Freedom funds. Choose the year closest to your 75th birthday (e.g.: if you were born in 1980, choose the 2065 fund.) You should see some option like ‘change investments’ and might have to do this once for future contributions and once for the money already invested in your account.

For bonus points, double-check your ‘beneficiaries’, or set them up if you haven’t before. You want to make sure your assets are sent to the people or charities you want to get them if something untimely happened to you.

Don’t have an employer retirement account? Use an IRA instead

If your employer doesn’t have a retirement account, or you freelance and don’t want to set up a self-employed IRA, open a Roth IRA at Vanguard instead, then set up automatic monthly deposits with this link after you’re logged in. The maximum yearly contribution if you’re under 50 is $6,000/year, and $7,000 if you’re 50+. Max out if you can.

I’m assuming a Roth is best for you since I’m predicting you’re at or under the 22% tax bracket (i.e.: you make less than $100,000 single, or your family makes less than $200,000 if married.) If your marginal rate is 24% or more and would rather save on taxes now, use the Traditional IRA instead.

You’re now retiring earlier, or more luxuriously, or both!

Boom! You just secured your age 60+ retirement in the time it takes to make a cup of coffee. Pat your self on the back, take a lap and hit the showers.

Next up, make this simple change to you direct deposit and never worry about spending too much again.

If you want to retire earlier than that, read this too.

Share in the comments how much you bumped up your contribution, and whether you changed your investments or beneficiaries!

The blueprint for retiring early – Part 1

I’m going to be able to retire early. Probably by age 40, maybe age 45 tops. I’m 37 now, and this is the blueprint I have followed to get within 3 – 8 years of retirement at a relatively young age.

Step #1 – Fix your spending

First, you have to fix your spending. I don’t mean ‘fix’ like it’s broken, I mean fix it as in only spend a constant, known amount of money. You might adjust this up or down over time, but for any given year you need to set a target spending budget and stick to it.

The key to fixing your spending is NOT by using a traditional ‘budget’, which no one does or sticks to, but with your employer’s direct deposit. Most companies will let you choose at least two or three different accounts to split your direct deposit into.

Let’s say you get paid monthly and have penciled out your budget at $3,000/month for everything: essentials + discretionary. You allocate $3,000 of your direct deposit to go to the checking account that you pay all of your bills and credit cards out of, and then deposit the ‘balance’ (rest of your paycheck) to a savings account which will ONLY be used for transferring money one way to your investment accounts ( = Roth IRA + taxable accounts.)

Having one single tub of money in your checking tempts you to spend everything most months, and then have nothing for unexpected or irregular expenses that only come around a few times a year. To avoid this problem, you should also having at least one other savings account that gets a fixed amount of money too, and use that as your ‘buffer’ fund for discretionary things that you can save up for and only buy once that fund has sufficient money in it.

I actually use multiple sub-savings accounts: one for travel, one for miscellaneous stuff I want like backpacking gear or household items, one for a future new (used) car when mine dies, etc, but do what is easiest to manage for you. If you sent $1,000 to your subsavings account(s) for occasional expenses and $2,000 to your checking for regular monthly bills, your early retirement financial picture would look like this so far:

Screen Shot 2020-05-07 at 10.38.36 PM

I’ve detailed exactly how to set this up, including what bank to use, here. For more on how to figure out what you’re spending in order to estimate your direct deposit needs, read this.

Once you have this banking system of accounts + automated transfers (including your all-important direct deposit) set up, there are only two points of failure:

1) you forget to transfer money from your sub-savings accounts back to your checking to pay for once-in-a-while expenses. Avoid this by using your bank’s app and making transfers as soon as you spend money that comes from a sub-savings account. Say you buy plane tickets for $1,500. As soon as you buy them, transfer that same amount from your Travel savings account to checking so that the money is there when your credit card payment comes due. (I recommend setting all your bills up to auto-pay for simplicity and to avoid late fees.)

2) The second point of failure is outspending the amount you’ve budgeted for. If you’ve correctly computed your recurring expenses that come from checking, you’re ok there. If you haven’t, either adjust your monthly deposits upward, or if it’s just a temporary blip, ‘steal’ money from your subsavings accounts to pay for a higher-than-usual monthly bill. For your discretionary expenses that you’re accounting for in your sub-savings accounts, you must wait to spend that money until you have enough in your sub-savings account to pay for it. For example, if you have a Travel fund, do not book your next vacation until you have enough in that sub-savings account to pay for it. This develops the simple-yet-essential habit of not spending money you don’t have.

Your goal in all of this is to steadily increase your rate of saving as your income increases over time. People with steady employment that fail to build wealth are increasing their spending to match their income increases. Thus they never ‘get ahead’, and with credit cards and debt, they can even spend enough to fall further behind despite worker harder and earning more over time.

For people that are serious about accelerating the date at which they can work for fun versus money, you want to eventually save 50% or more of your annual income. This is hardest when you’re just starting your career and your income is low, or if you’re just starting to get a handle on your expenses. Don’t be discouraged: any increase in savings is a big step in the right direction! I saved barely anything straight out of college (but I did save something), and now, 15 years later, I’m saving well over 50% of my take-home pay as my income has increased by keeping my expenses at the same level they were for the past ~10 years.

The rich get richer

Once you fix your spending, you’re now banking every windfall that comes your way. Bonus at work? You get to keep all that. RSUs vest? Bank it. Annual raise? More and more yearly savings moving you closer and closer to financial independence.

In Part 2 we’ll discuss Steps 2 and 3: maxing out tax-free savings and what investments to choose for maximum growth with minimal long-term risk.

How much money do you need to retire early?

You might want to first read my blueprint to early retirement. In order to retire, you need to know how much money to save by the time you plan to exit the rat race.

How do you know how much you need to retire?

The simplest, but not the best, way to is to assume you’ll need 20 – 25x your annual spending in order to retire indefinitely without any other income beyond your own savings. Divide your non-house net worth (all your retirement + other savings) by the amount you/your family would need to live on once you retired. Factor in extra spending for buying your own health insurance until Medicare kicks in, for kids if you got ’em (don’t forget about college), and anything else you can reasonably foresee.

Let’s say your family spends $72,000 per year ($6,000 per month) currently, and expects that to rise to $80,000 for kid’s expenses as they age + annual college savings, plus another $10,000 for catastrophic health insurance once you quit your job. That’s $90,000 you’ll need each year in retirement. 20x that is $1.8 million. 25x is $2.25 million. This is a good rough estimate, but you also need to consider what sources of income you can tap prior to age 60 and after age 60, including social security and any fixed pensions you’ll receive.

Figuring out before-60 money and after-60 money

To avoid fees & penalties, it’s imperative that you don’t tap your retirement accounts until you’re allowed to do so. In most cases this means waiting until you’re 59.5 to access any money in your 401k or Traditional IRA, and before touching any earnings in your Roth IRA. For your HSA, if you want to use it for non-medical expenses without penalty you must wait until you’re 65.

Roth IRA contribution early withdrawals are ok, though!

If you need to, you can access all of the contributions you’ve made to a Roth IRA over the years at any time without penalty or taxes, so keep good records of how much you’re contributed to any Roth IRA throughout your investing history. If your Roth IRA is worth $100,000 at age 50 and you had contributed $40,000 to it to date, you are allowed to take out up to that $40,000 at any time and for any reason with paying any taxes (since you already paid them when the money went in) or penalties. You could use this $40,000 if needed before age 59.5. When you hit 59.5, you can access the $60,000 in earnings as well without any penalties (or taxes, since it’s a Roth.)

Here’s how much you will need in pre-60 vs post-60 accounts based on your planned retirement age

You’re free to do some custom spreadsheet calculations on your own, or with a spreadsheet-loving friend, to make sure you’re saving roughly the right amounts in your ‘after 60’ accounts (401k/IRA/pension/social security) vs your ‘before 60’ accounts: taxable accounts + HSA for health care out-of-pocket expenses only + Roth IRA contributions.

A simple solution is to use this calculator created by Ian Johnson.

Or if you prefer, my clunkier Google Sheet (see table below) to look up your pre-60 and post-60 savings needs. Match up the age you plan to retire with the two multipliers on the right that tell you how many times your spending you need. (You can also copy this sheet and replace the blue-highlighted ‘1’ with your estimated spending to see it in dollars.)

For example, if you planned to retire at age 45, you’d need 11x your annual income to make it to age 60 under my ‘moderate’ risk scenario*

Screen Shot 2020-05-07 at 11.50.25 PM

If you needed $100,000 for your family to live on, you’d need to have $1.1 million (11 * $100 K) at age 45 in taxable accounts + Roth IRA contributions.

The same row above also shows that you’d need 7x your needs in your post-60 sources at age 45 (this money will keep growing and be even more at 60.) So that’s an additional $700,000 you’d need in 401ks and the like. That means you would need a grand total of $1.8 M at age 45 to retire on $100,000 a year using only your savings. (If you planned on social security or a pension or other income in retirement, you’d need less in your post-60 accounts.)

Screen Shot 2020-05-08 at 2.09.40 PM

This table can help you calculate when you can retire as well as how you should try to split your money between pre- and post-60 sources.

I personally have never not maxed out a tax-advantaged source in order to put more into a non-retirement source. This is because I’d rather just maximize my total wealth even if it means I’ll have a little more in post-60 retirement vs pre-60. That said, if you were really serious about not working at all in your pre-60 early retirement, you should consider how your wealth will be divided.

* 'Moderate' assumes 5% real market returns on that 11x of annual income from age 45 - 60. Risky assumes 6% real returns, conservative assumes 4%. These roughly correlate to the expected returns after taxes and inflation from a 90-10 stock-to-bond portfolio like the Vanguard Target Retirement fund that I recommend. What you actually experience will depend on the market and your particular tax and investment choices, but it should be close enough.

Now that you know how much you need, how do you know how much you need to save from now until early retirement?

You can use a retirement calculator like the one above to compute how much you’d need to save each year to get to your age target. This will help show you whether you’re on track, or whether you really need to cut spending (and/or make more money) in order to hit your target retirement age.

These numbers are not set in stone

These calculations give you a ballpark feel for what you need, but in reality you’ll need to be flexible. Can you lower your spending if the market takes a dive? Are you willing to go back to work, perhaps only part-time, if you need to? Will your health or any other circumstance require more money than you anticipate, and what can you do to mitigate that (hint: get and stay healthy)?

If you’re willing to work part-time or expect other sources of income like a pension or social security, you can definitely retire with less, but you should do some more spreadsheet math to estimate all this.

Lastly, remember that financial advisors like me tend to give cautious advice when it comes to financial risk. Given that, don’t only consider the risks of retiring too early; consider the risks of retiring too late. Whiling away your life in a passionless malaise in a career you’re not crazy about is a risk to your happiness and life-satisfaction. You might be better off taking more financial risk in exchange for less risk of regret. No one lies on their deathbed wishing they spent more time at the office.

With these estimates and my early retirement blueprint, how you want to live the rest of your life is up to you.

2013 retirement account updates – IRS contribution limits increase for IRAs and 401ks!

IRS contribution limits for 401ks/403b plans will increase to $17,500 in 2013 (up from $17,000 in 2012).   The 50+ age group can contribute an additional ‘catch up’ amount that will remain at $5,500 for 2013.

Additionally, Roth IRA contributions will increase from $5,000 in 2012 to $5,500 for 2013 for those under 50, and $6,500 in 2013 for those 50+.

For those boss ballers making six figures (nice work!), the Roth IRA contribution phase-out range is Adjusted Gross Income (AGI) of $112,000 to $127,000 for single tax filers, and $178,000 – $188,000 for married filers.  This basically means you can’t make ANY Roth IRA contributions if your income is at or above those levels.  If you’re close, check with your accountant, or crunch your AGI numbers in a program like Turbo Tax come January/February to determine if you can make any contributions for tax year 2012.

Keep stashing as much cash as you can in those tax-advantaged retirement vehicles!