I-N-D-E-P-E-N-D-E-N-T Do you know what that mean? – The Ultimate Guide to Financial Independence

From 1996 to 2010 on any given Friday or Saturday night I could likely be found face down, ass up and bouncing that thang at either someone’s basement house party, a university’s student union, a frat house, or a nightclub. While the soundtrack to my struggle twerk mostly consisted of borderline to blatant misogyny in the vein of “Can I play with yo panty line?” and “Put it in ya mouth,” periodically a song of female empowerment would make its way onto the DJ’s turntables. These tunes had a common theme: independence. Everyone from Destiny’s Child to Ne-Yo to Webbie were extolling the virtues of a woman who got her own house, her own car, and can do for herself. Of course whenever these songs came on I would be on the dance floor throwing my hands up and singing at the top of my lungs.

I had good reason to see these songs as a reflection of me. At 24 I owned a house, had an impressive 9 West and DSW supplied shoe collection, earned a higher salary than all of my friends (except for the investment bankers), paid my own bills, and had a bit of change stashed for emergencies. According to hip-hop and R&B if you looked up the word independent in a dictionary you should have seen my smiling face.

Since exiting my 20s and as I move through my 30s I have come to the realization that this definition of independence is shallow and even inaccurate. For all of my claims of independence I was still dependent on my employer to provide regular income, subsidize my health insurance, and keep me on staff so that I could live the lifestyle to which I’d become accustomed. After graduating from business school I was acutely aware of my dependence on a job when I remained not so funemployed for three months after graduation.

Now that I am once again sans employment, but this time without any pressing need to be employed I am viewing being independent in a new way. Now I see independence as no longer having the need to earn income. And the sooner I can get to that point the better.

Ahhh, FI/RE. The dream of gaining financial independence and retiring early has a small but obsessive following. There are quite a few people who have chucked the deuces to earning wages and gotten a jumpstart on retirement. He did it. She did too. She’s on her way. He’s one of the founding fathers and did it by 30! There were no windfall inheritances and with the exception of the last example, none are millionaires.

No lies, fairytales, or fallacies. I swear. How about we start with the basics.

What Is Financial Independence

Simply put, having financial independence (FI) is nothing more than having enough money to pay for your living expenses without having to work for a wage. Many people assume that this means having a Scrooge McDuck vault.

Although now that I think about it, that vault was the worst place for Scrooge to keep his money. All of those gold coins are earning zero interest and losing value due to inflation. I am now triggered by this gif, but the epiphany on the flaws of one of my favorite cartoons is a good segue into why you don’t need to hoard millions to be financially independent.

Money when invested makes more money. In the absence of being the richest duck in Duckburg, people achieve financial independence when their investments continuously generate enough income to finance their life indefinitely.

How much investment capital is needed to spit out enough income to finance your life? Calculate your annual expenses. Most people multiply this number by 25 or 30 (some go up to 50 to be safe) to set a target of how much invested principal they’ll need in order withdraw that expense year after year without hitting their initial investment. It’s called the Safe Withdrawal Rate and most peg it at 4%.

Let’s say you need $40,000/year to live the way you want. You saved $1,000,000 in investments (25X $40,000) that returned 7% interest/dividends each year bringing your balance to 1,070,000. Let’s estimate that 3% of that growth is due to normal inflation. You can still withdraw 4% of your investments, which gives you the $40,000 you need to live, and leave the rest to do it all again next year. Given this equation, logic dictates that the less it costs to live the less you need invested and the faster you will get to FI.

However, that is just the numbers side. Financial independence is also about gaining freedom. Look, I’ve known since pre-school that this is a free country so we can do what we want, but in reality most people aren’t free. Life obligations like these bills, this rent, and those kids often force us to spend a third of our life doing tasks that numb our minds and dealing with people that suck our souls in exchange for the money we need to keep the lights on, the roof over our head, and open mouths fed (see what I did there?). I spent years in cities where I didn’t want to live, working for bosses who didn’t see my value, and doing assignments that I didn’t care about because I needed the paycheck that putting up with the bullshit provided. I wanted to be a writer but didn’t have the option of pursuing that goal full-time while maintaining my life as I knew it.

Never want to leave your job? As I learned back in September, sometimes the jobs we love aren’t guaranteed to last forever. Also, many of those who are cool with their day job still don’t have the freedom to step away from working when life calls their attention elsewhere. How many new mothers have no choice but to be back at work only weeks after giving birth, lest they forfeit the wages they need to buy diapers, onesies, formula, and secure childcare? Way too many.

Now that I am in the position of not needing to work for income to pay for my living expenses, albeit not indefinitely, I have to say that I like it. I devote my time to what brings me fulfillment, whether that be watching General Hospital, writing, or building my own business. I was reading a recent post on J. Money’s blog, Budgets Are Sexy, on how to measure how long you can survive without a job. You divide your liquid assets (cash and investment accounts) by your monthly living expenses to get the number of months your assets will last. According to this measure I could liquidate all of my accounts and live for 53 months. I ain’t trying to do that, but having a small taste of independence only makes me crave more.

How Sway!?

I know that you are probably reading this and thinking, “That’s cute and sounds good, but with the way my bills and bank account are set up, getting to a million dollars ain’t happening for me.” At face value, you’re absolutely right. However, maybe the bills and bank accounts could be set up differently. While I do not have all the answers, from what I’ve gathered by reading way too many FI/RE blogs, there are three basic components needed to walk the path to FI.

Low To No Debt

Debt is the crab that keeps us trapped in the barrel. Not only does it eat up monthly cashflow, servicing it also increases the amount of money needed for living expenses, both of which are crucial components of the FI equation. Even if the debt costs little to nothing (i.e. super low interest rate), it can still add thousands to monthly expenses if the principal and payments are high. Getting rid of debt as quickly as possible allows you to keep more of your money and invest it sooner.

Although I have been debt-free in the past and currently have a low debt burden, I am not the Moses to lead you to that promised land. There are ones greater than I who can take you on that journey. Of course there is the granddaddy of paying off debt, Dave Ramsey and his snowball method. Here are the basics:

1. List all of your debt (except primary home mortgage) from smallest to largest. ALL OF IT.
2. Pay the minimum on all but the smallest debt.
3. Throw as much money as you can get your hands on at the smallest debt until it’s paid off.
4. Apply what you were paying on the now paid off debt into the next smallest debt in addition to the minimum payment. Do this until it’s paid off.
5. Repeat step four until all debt is paid off. Voila!

People have been following his guidance since the 1990s and obliterated tens to hundreds of thousands in debt. She did it. They did it too.

Dave can be quite stringent in his guidelines and brusque with his guidance so he ain’t for everyone. Not a problem. There are other role models out there. He paid off $87,500 in student loans in 2.5 years with frugal living and side hustles. This HBCU alum is throwing everything and the kitchen sink at $63,000 of debt. This guy torpedoed $30,000 and wrote a book about it. I may not be a role model, but these people definitely are.

Low Weekly/Monthly/Annual Expenses

Even if I were to rid myself of my mortgage and student loan debt (~1800/month), it would still cost me about $3500/month or about $42,000 annually to maintain life as I know it. That number includes food, clothing, entertainment, property taxes, various insurances, transportation, vacation, utilities, cash savings, and miscellaneous expenses. This means that my principle investments would need to be $1,050,000 for me to no longer need a paycheck. There are people whose target number is much less than mine because their lifestyle can be maintained on $3000/month, $2500/month, and for some people even less than that.

High Savings Rate

While many can get to FI by age 65 by following the traditional savings and investment rules, (i.e. contribute in the 401K up to the company match, save 3-6 months living expenses for an emergency, contribute $5500/year to a Roth, etc.), people on FI/RE are looking to speed up the process by ten, fifteen, even twenty or more years so they can give their jobs a special goodbye wave.

A 10 to 15% savings rate doesn’t get it done, but a 50+% rate definitely does. Let’s do some math. Let’s say you make $75,000/year and live on $45,000. Investing $7500 annually at 7% return it would take almost 35 years to accumulate the $1,125,000 needed to take disbursements at the Safe Withdrawal Rate.

Take that same $75,000/year salary and increase the savings rate to 50% and you get to that $1.125MM in less than half the time. Now I know what you’re thinking.
People with very low living expenses. And who tends to have very low living expenses? People with little to no debt.

Mind The Gap

The fastest way to FI is to widen the gap between income and spending. I talked about it before when suggesting ways to prepare for an inevitable recession. Here’s a refresher.

Spending less than you earn is simple in theory but much more difficult in practice. Before (f)unemployment I enjoyed a salary in the top 5% of incomes in the U.S. and still had a helluva time finding ways to cut spending. Although I have found a few places to cut back (auto insurance, utilities, saying goodbye to cable), there are others who have turned spending less money into a way of life.

Frugality

Usually people associate with frugality with being cheap or miserly. Although these descriptors may apply to some, the majority of frugal people are are really just excellent at prioritizing. They understand that money is a finite tool that cannot be used everywhere at the same time, so they set goals and spend accordingly. For them it is more important to save, buy a house, pay off debt, retire early, travel the world, or whatever sets their heart aflutter than it is do anything else whether that be own expensive electronics, live alone, have nice furniture, or whatever else the prevailing culture says one should do with their money.

Frugal living got this blogger out of debt and into abundance. Over at Yes, I am Cheap, Sandy doles out a lifetime’s worth of advice on how to cut expenses big and small. Some people come to the realization that the best way to spend less is by having less. Embracing minimalism is a natural evolution from frugality and can allow you to happily live with less home, less furnishings, less clothes, less stuff. She does.

Mo’ Money, Mo’ Money, Mo’ Money

For some people there is no fat to trim from the monthly spending. Widening the gap falls to the income side of the equation.  This is also true for those who can’t imagine life without bottomless brunches, trips to Venice, a luxury vehicle, or other indulgences. That’s cool. Personal finance is personal and everyone values different things for different reasons.

Increase your salary

Wealth Noir recently posted a useful guide to negotiating salaries and raises. Sometimes your current job is not the place to get the big raise. Instead of being satisfied with 1-2% annual increases, more workers are simply leaving their jobs for more lucrative pastures, often gaining a 10-30% or more salary increase in the process. And the best time to find a new job is when you already have one. Paychecks and Balances did a great podcast on job hopping to increase salary. Ramit Sathi’s blog has a repository of career resources too.

I’m a hustler, baby!

A raise not in your future? That doesn’t mean you can’t still make more money. I once heard that the average millionaire has seven concurrent income streams. I couldn’t find a study to confirm it, but I totally buy into the concept of having more than one way to make money.  I took to mystery shopping to continue to enjoy dining out and a gym membership while maxing out my 401K contributions and making up to three times the minimum payment on my student loan every month.

While the $90 or so I earned every month from mystery shopping was enough for me, others are much more aggressive when it comes to side hustles. So far this year, Financial Panther has hauled in more than $28,000 from income outside his 9 to 5. He does everything from renting a spare room on AirBnB to dog walking all while holding down a full-time job and having a life.

Want to add another source of revenue to your arsenal, but don’t know where to start? Check out this list of 99 side hustles you can start now!

Priorities

Lowering living expenses and increasing income ultimately comes down to prioritizing. As Paula at Afford Anything says, “You can afford anything, but you can’t afford everything.” If you want FI you probably can afford it, especially if you follow the steps outlined above. However, getting to FI will likely mean choosing not to afford something else.

When I was 25, a high school friend told me that he was quitting his job at a major tech company to bike through Europe for a year.

I would have loved to be able to do something like that. Obviously he had that luxury because his paycheck was fatter than mine.

It turned out that we were on par salary wise. However, while I had a nearly $1000/month mortgage payment for the beautiful 3 bedroom, 2 bathroom house I had all to myself, for the last three years he had been living with three roommates and paying less than $400/month in rent. He also almost never dined out and saved 30% of his pay in cash on top of maxing a 401K. He did all of this while also providing financial support to his parents.

I am not saying that his choices were better than mine. I am simply illustrating how our spending reflects our goals and values. I loved the life I lived in my 20s. I enjoyed the experience of going to new restaurants with friends. I valued owning a home that I loved. However, my friend was more intentional with using his money as a tool to build the life he wanted.

FI is no different. A popular book that illustrates these choices in terms of the hours in our life is Vicki Robin’s Your Money or Your Life. When you start thinking about spending money in terms of how much of your life the purchase costs it can change your entire perspective on what you really value.

But I Got These Chirrens

Obviously it is much easier for a single person without money pits dependents to structure their life and finances to reach FI sooner than later. However, that doesn’t mean married people or those with families cannot do the same. This physician, husband, and father of two achieved FI at the age of 39. Not making doctor money? Check out this teaching couple’s story. Not only are they early retirees, they’re also millionaires and got that way on teachers’ salaries. Even without kids, just getting your partner on the same financial path can be a struggle.*

If this is the road you want to hoe, the rules remain the same. However, prioritizing becomes that much more important because the choices you make are shaping someone’s life. Although I have yet to impregnate Idris, Kofi, or Shawn Carter with my babies, I do recall all of the money my parents invested in me. There were dance lessons, karate classes, Girl Scouts, Jack and Jill (Eastern Region 4EVA!!), and more, all financed in the hopes of making me a well rounded, functional adult. I guess it worked.

Since it’s not my life, I am no expert on managing family finances. I will leave the advice giving to these people, and her, and them.

What To Do With All That Money

Prioritizing FI and finding the money to fuel that goal are only the first step. Once you are set up to save 50%, 60%, or more of your income, the worst thing you could do is Scrooge McDuck your money (i.e. put it into a savings account). Even a higher interest bearing account like Ally or Capital One 360 Money Market will only get you a little bit over 1% in Annual Percentage Yield. If you want your money to make money you have to invest it.

Preferably, a lot of places.

The Stock Market

Yesterday the Chicago Tribune (and other outlets) reported that the surging stock market has powered American household wealth to $96.9 trillion this fall. Alas, not all Americans are enjoying this increase as only 18.7% of taxpayers directly own stock outside of employer sponsored retirement plans. Staying out of the stock market leaves many households on the outside looking in on an economic boom of which they are not a part. For Black households this is particularly troubling as lagging behind in stock ownership is one of the drivers of the racial wealth gap. Investing beyond contributing to an employer sponsored retirement plan is new for many black people, even those earning middle income wages. Tela Holcomb is a former stocks and options trader who now doles out investment advice on her blog. Check out her 5 Tips to Being a Great Investor.

What stocks should you buy? A popular option for many FI/RE adherents is to invest in a little bit of everything with index funds. An index fund is a mutual fund with a portfolio constructed to match or track the components of a market index (like the S&P 500). People like them for the broad market exposure and low fees. A popular one that everyone and they mama can’t stop talking about is the Vanguard Total Stock Market Index Fund (VSTAX). The Choose FI podcast did an episode on how to buy VSTAX.

The most important thing to remember when investing is that the best time to do so was ten years ago. If you missed that window, then the next best time is now. Why? Time. Do you remember the question about choosing between receiving a penny now that doubles in value everyday for 30 days or $1,000,000 in 30 days. If you chose the $1,000,000 30 days from now you just missed out on and additional $9,737,418.24. Compound interest is the gift that keeps giving (if you’re on the right side of it). The longer your money is invested the more it compounds, so get your dollars in the market. STAT.

Strength in Diversity

Just like it’s good to have more than one source of revenue it is also a good idea to have more than one investment vehicle. Although the stock market returned 7% annually for the period between 1950 to 2009 and long term investors (10 years or longer) can expect to come out ahead, stocks are still a volatile investment in the short run. Some years (like right now) see tremendous gains, and others (I’m looking at you 2008) leave investors with 40% declines. Depending on the market you could be at your FI target one day and come up way short the next. While this is no reason to NOT invest in stocks, it does make sense to also spread the wealth to other income producing assets.

Rental Property Income

Real estate investment is very popular with those seeking FI. Not only do you own the asset and equity in a property, that asset kicks back monthly revenue in the form of rents. Paula Pant drove the real estate train to becoming a financially independent millionaire. John and Richelle run an entire blog devoted to real estate investing. Live in a real estate market far beyond your price range? This couple purchased out of state rental properties in areas with more reasonable prices. I, myself was pre-approved and shopping for my first rental property before I was laid off. If you have money burning a hole in your pocket and think you can do the landlord life I highly recommend that you go to the Grand Puba of real estate investment sites, Bigger Pockets, for everything from the basics on how to get started to thousands of curated resources and tools for every aspect of being a real estate investor.

Business Ownership

If you’ve read Robert Kiyosaki’s classic book Rich Dad Poor Dad then you know that one of the sources of his wealth is owning equity stakes in businesses. Starting a business from scratch may not be your ministry, but buying a stake in someone else’s could yield a nice return of passive income. Usually, Equity investors provide a business with capital (mostly in the form of cash) in return for a percentage of the profits and losses.

In some cases people make debt investments in a business in exchange for interest income. While you don’t own a piece of the business, you are at an advantage if the business goes bust because debt has to be paid before shareholders are. Before you buy into your cousin’s barbershop be sure to understand these 12 rules for investing in a small business.

Don’t Forget the IRS

While financial independence is about gaining freedom from the necessity of earning wages, it does not give freedom from the IRS. Part of that extra income to widen the gap and the passive income to fund your funemployed life belong to Uncle Sam. How much of it? Well that’s up to you.

Ordinary Income

As I said before, not all income is taxed the same. With the exception of pre-tax savings like an HSA, 401K, FSA, commuter benefits, and healthcare premiums, the income you earn at your job is taxed first and you spend what’s left over. When running your own business through a side hustle or full out ownership the order of operations is reversed. You pay your business expenses first then pay taxes on what’s left over.

If you decide to bring in extra money through a side hustle that doesn’t give you a W-2 (AirBnB over 14 nights a year, Uber driving, Fiverr, Instacart delivery, and other jobs in the gig economy), check out Young Adult Money’s comprehensive guide on how to pay your taxes for this income.

Tax Deferred

Money contributed to retirement accounts prior to paying taxes on it is considered tax deferred. This includes contributions to a 401K, pension, traditional Individual Retirement Account (IRA), SEP IRA, etc. Funds deposited lower your present taxable income, grow tax free (i.e. you don’t get taxed on the growth every year), and when withdrawn at age 59.5 or later are taxed without penalty as ordinary income.

Tax Free Growth

Another type of tax advantaged retirement account is the Roth version. In this scenario post-tax dollars are contributed, but the growth and withdrawals are tax free. Additionally, principal withdrawals before age 59.5 are allowed without penalty.

Triple Tax Advantaged

Then there is the Cadillac of retirement accounts that the IRS will never touch: the Health Savings Account (HSA). Contributions are made with pre-tax dollars, grow tax free, and can then be withdrawn sans taxes for qualified medical expenses. Need the money for something non medical? That’s cool. If you withdraw it at age 65 or later it’s simply taxed without penalty as ordinary income. But don’t do that before 65 or you will get hit with a hefty 20% penalty.

There is a Catch

All of these tax advantages do not come without stipulations. There are contribution limits for employer sponsored pre-tax retirement accounts, SEP, Roth and Traditional IRAs, and HSAs. Also, not everyone can use everything. There are income limitations on accessing Roth IRAs and deducting contributions to a Traditional IRA. Healthcare spending accounts are only available to people enrolled in high deductible health plans.

Oh, and did I mention that pre-tax retirement accounts are subject to required minimum distributions at age 70.5? How much? Well that depends on how much you’re holding. Sitting on a $2,000,000 nest egg? You’ll be withdrawing $75,471.70, which will be taxed as ordinary income. Don’t need that much money? It doesn’t matter. The IRS says you’ve gotta take it, so you’re gonna take it.

Additionally, not every type of account is right for every type of person. Lower income earners benefit from contributing to a Roth (if they can) because of their lower tax rate. High income earners tend to be better off with pre-tax retirement investments in order to lower their current taxable income. Don’t know which one is right for you? I found a thorough guide to the Roth vs. Traditional question at the Cash Cow Couple’s site.

Tax Shields

One of the keys to getting to FI as fast as possible is avoiding as much taxation as possible. It is a labyrinth of navigating your current tax rates, your future tax rates, and the ticking time bomb of age 70.5. Making it even more complex is figuring out how to get to the money you stashed in retirement accounts before the official retirement age of 59.5, but without any penalties and with as little tax as possible.

It makes my head hurt too, but I’ll walk through it slowly.

Starting With The Tax Advantages

Although retirement accounts come with more red tape than Scotch can make, they are still the best place to start the investment portion of your FI journey. Any time the government tells you that you don’t have to pay taxes you say, “Yes!”

Winning the post-tax way

One of the best reasons to get rid of debt and keep your living expenses low when you’re in your early 20s is to have the money to max out a Roth IRA while your income (and thus your tax rate) is at its likely lowest point in your career. Some people are so good at this that they lower their federal income tax liability to under 10% through pre-tax contributions to an employer sponsored retirement fund, HSA, and other pre-tax benefits then max out their Roth with money that is darn near tax free.

Consider the example of our hypothetical friend Arianna. Ari earns $60,000. She contributes the federal max of $18,000 to her employer 401K. She is also enrolled in a self-only high deductible health plan with a $50 monthly premium and maxes out her HSA contribution at $3400. She purchases a $100, monthly unlimited public transportation pass through Wage Works.

Before paying any taxes Arianna has already lowered her wages by $23,200. When she files her taxes Ari deducts $2500 of student loan interest and takes the standard deduction of $6300 for single filers. After the personal exemption of $4,050, her total taxable income is $23,950. Her federal tax obligation is $3130, an effective tax rate of 5%. If Arianna wants to contribute $5500 to a Roth IRA, she only needs to earn $5775 before taxes to get there. The higher the tax rate the more money required to net the maximum contribution.

What makes this even sweeter is that in twenty years at 7%** annual return, her initial investment would be worth $21,283 and she would have only paid $275 in federal income tax on it (a 1.29% effective rate).

Pre-tax victories

Our friend Arianna came out like a bandit with the IRS and her Roth IRA reaped the benefits. However, she would not have gotten there without the help of salary reducing pre-tax contributions, particularly that massive 401K max out. While that money isn’t out of the taxation woods yet, she bought herself time and a lower tax bracket for now. The HSA contribution was no slouch either, shielding another $3400 that if used for medical expenses will never see a cent of taxation.

The ultimate loophole

Whenever you make money the IRS wants to know about it. However there is one exception when they do not care how much you make. Thanks to rich people in Augusta, GA who make tens of thousands of dollars renting out their homes during the Masters Tournament none of us have to report income earned from renting a primary residence for 14 nights or less. It doesn’t matter if you rake in $250 or $25,000, as long as you rent for no more than 14 nights that money is all yours. It’s called the Masters Rule and I’ve definitely used this to the tune of several thousand dollars a year of AirBnB income.

If this wasn’t enough cause for celebration, Financial Panther put me on to a brilliant use for this money: funding a Roth IRA. As long as you made other wages during the year and your AGI is within the income limit, why not take that tax-free money, put it into an account with tax-free growth and withdrawals, and never pay a dime in taxes. Do this every year for 20 years and at 7% return* you’re looking at over a quarter million dollars in tax free money.

Don’t Leave Out the Taxable Accounts

Although avoiding as much taxation as possible is paramount to FI, that does not mean that taxable investment accounts like stocks and mutual funds aren’t your friend. Passive income from investments is even more tax advantaged than that from side gigs because capital gains are taxed at a lower rate. Use pre-tax savings to get your taxable income into the 10 and 15% brackets, (max of $37,650 for single filers, $75,350 for joint filers) and your capital gains are tax free. Settle into the 25%, 28%, 33%, or 35% brackets and your capital gains income will cost you 15%.

Most importantly, your taxable accounts (along with any rental or business income you may have), will be getting you through your first years of FI, if you decide to also retire early. You need this money while setting up your pre-tax retirement accounts for maximum usage and minimal taxation. Which brings me to…

Young Money

I know you’re probably reading all of this and thinking, “How am I supposed to be financially independent in 5 (or 10 or 15 or 20) years when I can’t touch most of my money for 30 (or more) years?” That is where you need the Mad Fientist, a former software developer who retired at 34 by figuring out all the math in the world to hack the tax code and get to FI sooner. Definitely read his article on the best options for accessing retirement plans early BEFORE channeling your inner Veruca Salt.

Time to Pay the Piper….Pennies

Now we still have to figure out a way to keep all of those yummy pre-tax contributions out of Uncle Sam’s hands before he pries them from ours at 70.5. Once again the Mad Fientist is here to guide us through. First, he points out that “Standard retirement is part of early retirement.” Even if you chuck the deuces to your employer at 35, it’s very likely you’re going to be around at standard retirement age too. At 59.5 you don’t need to figure out ways to sneak money out of your 401K or Traditional IRA. You just do it.

However, if you’re a decade or more away from 59.5 that doesn’t mean the money in pre-tax accounts has to sit there. The Mad Fientist brilliantly shows that if you slowly start converting the money in these accounts to a Roth that there are ways to keep the funds tax-free. The key is a lower income with FI (due to early retirement).

Let’s take the example of our favorite Bickersons, Maxine and Kyle. They’re now 40 years old and have chucked the deuces to the law firm and stock brokerage, respectively. Their annual expenses are $55,000 and they have $1.5MM saved between taxable investments and tax advantaged retirement accounts. They now earn $20,000/year in ordinary income (Maxine still dabbles for a client here and there).

They take advantage of being in the 0% tax bracket for capital gains to withdraw $45,000 from their VSTAX fund free of federal income tax. With another $10,000 to go before being pushed into the 15% capital gains tax bracket they convert 10 G’s from their IRA to a Roth, and it is added to their ordinary income. Being the tax savvy people that they are, Kyle and Maxine claim $30,000 in tax deductions, effectively wiping out their ordinary income and thus not owing any federal tax. They lather, rinse, and repeat this process every year until they turn 59.5. BAM! $190,000 in tax free income. The Mad Fientist calls this a Roth conversion ladder.

Wait Just a Little Bit Longer

They may be annoying money grabbers, but the good folks at the IRS aren’t stupid. They know that people will use low income years to funnel money from tax deferred accounts into Roth accounts with little to no taxation. Because the principal in a Roth can be withdrawn penalty free before 59.5, the IRS mandates that conversion contributions be in the account for 5 years prior to withdrawal.

The Tools of the Master

The coolest thing about the Mad Fientist is that he took all of his research and experimentation then created a web application for figuring out your FI numbers. Yes, I know that I am gushing like a fan girl. It’s because I am.

Catching Fire

I am sure that by this point you fell down a rabbit hole of all the links I’ve provided. While some of you are ready to sell almost all of your earthly possessions, learn how to do your own oil changes, and live the rest of your lives on less than $30K of income, I know for many of y’all

Neither am I. As Damien at Wealth Noir said, “I be balling…just a little.” Like me, Damien likes nice stuff. Ain’t nothing wrong with that. However, as I said earlier (oh so many words ago), having nice stuff means not having something else. Does it mean that you can’t have FI?

The College Investor examined FI/RE for non-frugal people. He offers words of caution about trying to speed up the time to FI by cutting living expenses unsustainably low then spells out the key to what Todd Tresidder of Financial Mentor calls “fat fire.” Financial independence for those of us who like nice stuff comes down to three things: starting early (what did I tell you about the interest that compounds?), not wasting money (i.e. prioritizing), and earning more. If I had remained with my former employer and saved 50% of my salary, I would have been able to achieve FI to maintain $100,000 in annual expenses after less than 14 years. Drop my spending to $80,000 and I’m free at last, free at last, thank God almighty, I’m free at last in under 12.

Everyone’s number is personal. Mine includes the annual expense of protecting my assets from catastrophic events that I cannot afford through insurance. I’ve also factored in annual vacations and a luxury clothing item or accessory every year.
I also would like some wiggle room in my budget, just in cases. In order to reach FI in the next ten years I need to save $150,000 annually. Damn, I’ve gotta sell a whole lot of greens to make that happen. Since time is of the essence I better get on that.

Final Thoughts

Making financial independence a near term goal instead of a someday decades in the future is about having the option to live the life you want that reflects your values. For some people that will look like traveling the world and for others it could be having more time to spend with family. FI provides the freedom to change your mind and let go of the things in life that no longer work for us. It lets us move to new cities to explore untold adventures without predicating those aspirations on a job.

Does FI have you rethinking what it really means to be an “Independent Lady”? Is it something you’re well on your way to achieving? Never even thought about it before reading this? Already there? Hit the comments and share your thoughts, your FI game plan, or what life is like now that you’re on the other side. And if you found this tome helpful, please do share it with others (because sharing is caring).

*I don’t know why I insisted on using that gif. I’m still not over Atreyu losing Artax.
**The 7% return is for illustration only. Actual returns will vary. Investing in mutual funds involves risk, including possible loss of capital.

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