You read the title and probably had the same reaction I did. How? What does that even mean? I know this is a crazy idea, but there are many people who have found ways to achieve early retirement and I’m going to touch on some of those ways with a little Habesha Finance twist. So let’s not waste time, because I’m sure you want to figure out just how early retirement works. With today’s article and many more to come I hope to help you unearth this opportunity you could have at early retirement should you ever want or need to.
Live Below Your Means
Self-explanatory right. However, very hard to accomplish. Still, with the goal to achieve early retirement in mind you will have to do what seems impossible. But, it’s not! You need to be tuned into your spending habits and start cutting out all those frivolous and wasteful habits. Generally, good personal finance always involves living below your means.
So, no financing vehicles period. Especially on cars you can’t afford to purchase outright. One of the greatest obstacles to your financial independence is consumer debt and cars are one you can definitely do without. I actually talk about financing cars and the true cost of this bad decision and you always have that as a reference to go back to. Another big part of living below your means is budgeting. Take control of your finances and be aware of what’s going in and out of your bank account. Start saying hello to budgets and goodbye to debt today!
Avoid Having Debt
Right now there is a growing community in the financial world called “FIRE” (Financial Independence Retire Early). I’ve been listening to some of these guys on their podcasts and researching their websites and the information they provide is powerful. If you’re interested in getting into this community I recommend you check out The MadFientist and ChooseFI to get started. With that being said I should mention some of the advice they give is great and some I respectfully disagree with like their credit card ideologies and principles. At Habesha Finance we teach you to get out of debt and stay out of debt and never sign up for a credit card no matter what. The FIRE community definitely encourages not having debt and making sure credit cards are paid off monthly so that you don’t get penalized with interest charges. Still though, I cannot and will never condone the use of credit cards. Maybe it’s a little old-fashioned of me, but that’s where I see more people losing than winning and that kind of debt is easily avoidable.
Save Like Crazy
There’s no doubt saving is important. Read my last blog on saving for retirement and how important saving for the future is. The folks in the FIRE community are amazingly saving roughly 40-75% of their income and sometimes more. They’re retiring in their 30s, 40s and early 50s! I understand while saving 40% of your income can be a difficult task try your best to start with something and work your way up. It’s also important for anyone to understand taxes and how you’re affected when you save in tax-deferred accounts. The benefits of saving are too great to pass up.
Understand Taxes…As Much As You Can
Taxes can be confusing…actually taxes are confusing and tax laws are always changing with every new president that comes into office. This is why you should have a tax professional available to help you when you need. Honestly, even I make sure I read as much information and go to as many professionals as I can when I need help with taxes, investing and other personal finance issues. When you begin to understand taxes and how you can maximize your savings and taxes then you can truly begin the path to achieve early retirement.
Traditional IRAs, 401k, 403b, 457b
At the very least everyone who is earning a paycheck needs to have a traditional IRA (Individual Retirement Account) if you don’t have access to a 401(k), 403(b) or 457(b). This is where you are able to get the tax benefit of investing. No matter your income, if you (and your spouse) are not covered by a plan at work, then your deduction is allowed in full.
What I’ve learned from the FIRE community is that they are about maxing out all their tax-deferred accounts first and then if possible contributing to a Roth IRA, Roth 401(k) and taxable accounts. Their whole premise is to take advantage of the present tax benefits while also working with future tax laws to continue benefiting later.
For a really great read, check out The MadFientist’s article Traditional IRA vs. Roth IRA – The Best Choice for Early Retirement. He does a really good job explaining the principle behind this which is ultimately called the Roth IRA Conversion Ladder. Basically, in your high-income years you heavily contribute in tax-deferred savings accounts like a Traditional IRA or a 401k and when you retire early you start making small conversions to your Roth IRA while waiting 5 years to make withdrawals. The idea is that when you retire early you have 0 or little income with 5-years expenses saved on the side so when you convert the small amounts from your Traditional IRA to a Roth IRA the income tax you pay on that conversion will be very little. You’ll also avoid any penalties on withdrawals, because you waited 5 years before making a withdrawal from what you converted.
My only issue with this is we don’t know what the tax laws will be in the future. Like I mentioned earlier tax reform is always an issue with our government. This somewhat complicated path to achieve early retirement isn’t for everyone, but I will say that you can never go wrong with simply investing within a Roth IRA. It’s an easy way to save and invest without having to go through all the hoops and hurdles to get the benefits mentioned earlier. Even if you’re not within the income limits, go ahead and contribute to a Traditional IRA and you can do what’s called a “Back Door Roth” conversion. This is where you would pay income tax on the amount you convert an amount from your Traditional IRA to a Roth IRA. From there your money in your Roth grows tax-free and you can make withdrawals tax-free and penalty free after 5 years of each conversion you make. For more information on this check out this article on Back Door Roth IRA.
As you can see in this article there is so much information out there on early retirement. Your best chance of achieving this pretty awesome status is to do the research, study the laws and consult professionals. In the meantime thanks for reading and if you have any questions/comments feel free to share below.
