[Editor's Note: Today's WCI Network post is from Physician on FIRE and is all about how to reach financial independence. If FI is on your radar, you'll love the lineup of speakers and talks we have at the WCICON21 March 4-6. Click here for a complete list. Can't make it March 4-6? Registration gives you lifetime access to all 50+ hours of content.]
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 their present lives at work and at home. The freedom to live life 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) is also worth maxing out. You can withdraw this money at any age when you leave your employer. I’ll be collecting on mine starting in 2021.
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 2021, a family can contribute $7,200 to an HSA. The max for singles is $3,600.
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 $6,000 into a Roth IRA or $7,000 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 $12,000 to $14,000 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.
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 these is $13,500 in 2021.
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.
#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 recently became an owner of farmland via AcreTrader and have made several other equity and debt deals via different platforms (see my AcreTrader Review).
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 take-home 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.
#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.
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 a Student Loan Planner will more than pay for itself.
To check the latest refinancing rates from top companies and cash back offers worth hundreds of dollars, see this Student Loan Refinancing and Consolidation Guide.
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.
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. I just went back to using YoutubeTV to get my football fix after a six-month hiatus with no cable television channels.
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. WCI Recommended Insurance Agents can 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.
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 additional valuable steps have you taken to become Financially Independent? Comment below!