April 25, 2017 "Retirement" vs. Financial Independence
Presented by Reed Bermingham
I refer a lot to my clients achieving Financial Independence, and sometime people wonder why I tend to avoid the term retirement. In working with a lot of clients my age, it’s become crystal clear to me that my generation has an entirely different view of what their life looks like in their 50’s and 60’s. Unlike our parent’s generation, my peers are not so much looking to lock in with one company, devote 30 years of service, and count down the days until they can retire, collect a pension and social security, and find hobbies to fill their free time. This stems not just from personality changes between these generations, but through a couple specific changes in the financial landscape:
I for one am not confidently counting on social security to fund my later years, nor should you. We are not yet clear on exactly what will be left of social security in 20 or 30 years from now, or how the program will evolve (or devolve), but we are fairly certain benefits will be a fraction of what they are now estimated to be. This poses a challenge for people my age, and my clients – how can I fill that gap and create income for myself later in life? I’ll touch more on this shortly.
Retirement Plan Changes
You are most likely offered some time of retirement plan at your job. It might be a 401k if you work for a public or private company, or a 403b if you are a teacher, or another alternative plan depending on the sector in which you work. They are all inherently the same type of vehicle, and the financial term for them is Defined Contribution Plan. Contribution is the key word here, because your future benefit from this account is dependent upon the contributions that went in over the years. In other words, it’s up to you to save for retirement. This is a profound and important shift in recent years from the type of retirement plan your parents might have been accustomed to. Plans in prior years were known as Defined Benefit, which means that the plan is designed not around your contributions, but to pay you a specific benefit at retirement. This is where your parents pensions might have come from. These plans still exist, but there has been a massive shift to the Defined Contribution model to put the onus on the employee to save, rather than the company, or the government to provide social security.
On top of these changes in the retirement landscape, as previously mentioned, there is a significant shift in personality when it comes to how individuals my age approach their professional life. Not as a whole, but it’s significant. Many people my age work in fields that are ever-changing, where the future is uncertain and opportunity for growth is tremendous. This not only leads to people changing jobs several times throughout their working years, but it also counteracts the mindset that they might one day just stop working entirely and sail off into the sunset, pension in hand. Many clients envision a future where they work on a pet project, start a company in retirement, work part time in the field they were a professional in, or work as a consultant in some manner. This is not only due to the perceived need to do so, but a genuine desire to always be pursuing new opportunities. In other words, because they want to and they can, not because they have to. And this is what I mean when I refer to financial independence.
So, you might ask – how can I pull this off? If you’re like me, and don’t necessarily ever plan to “retire” in the traditional sense, here’s a couple ways to set yourself on the path to financial independence:
- Make sure you are utilizing the correct retirement plan. Like I mentioned before, there are a myriad of different retirement account options out there, depending on where you work. If you’re self-employed, the options become even greater. Additionally, you can often stack different accounts together for maximum benefit, including investing in an IRA or Roth IRA outside of your company, if eligible. Eligibility requirements, contribution limits, and general rules for retirement plans can be very confusing to many people who do not work in finance, but a Financial Advisor (such as myself) can help you make sure you are directing your income to the right vehicles.
- Unfortunately, there are limits to what can go into retirement accounts, because you obtain tax benefits for contributing to them and the government isn’t too fond of letting go of significant tax revenue. Since you are capped in these accounts, it’s rare that somebody is able to put away enough into a single retirement account to live on for 30 years. So, you’ll have to make sure you have a multi-tiered strategy to create income for yourself later in life. Here’s a couple ways:
It might seem obvious, but like you’ve heard before, don’t put all your eggs in one basket. As great as a retirement account is now while you’re working, every dollar that comes out of it later in life (in most cases) will be fully taxable. This can be toxic to somebody who only has that one account to rely on for income. What if you need a lump sum above your monthly income for a vacation, or new car? If the only place you have to pull from is a retirement account, it could push you into a higher tax bracket, which can cause you to fork over a significant portion of your withdrawal. Therefore, you want to make sure you have a savings plan into a standard investment or brokerage account to supplement your income later on, or provide for lump sum distributions from money that has already been taxed.
I’ve seen a lot of clients be very successful adding real estate to their savings plan during their accumulation years. In an ideal world, say you’re 30 years old currently. Perhaps you purchase a condo that you in turn rent out. Ideally, the rental income covers your mortgage and other expenses, or most of it, causing you to not have to come out of pocket much, if at all, to pay for it. 30 years pass, and the mortgage is paid off. You’re now 60, you own a hard asset that hopefully has appreciated over the years, but even better, it now provides you a monthly income that is yours to keep. This can be a great strategy you can employ now to provide income later. I’ve alluded before to times where debt can be leveraged as an asset, and this is one of those times.
As I always say, every situation is unique. There are several other elements here that play into your overall plan for financial independence – taxes, a business you might own, insurance, etc. A good advisor can help you design a plan that covers all the necessary bases to build a foundation and ultimately afford yourself the luxury of generating your own income, leaving you to do what you love, not what you need.