Early retirement sounds like a myth.
Maybe you believe in it a little bit, but think it is limited to those born with a silver spoon or winning the lottery. An inheritance or winning the lottery is a definite possibility but not one you can plan on experiencing.
Two things you need to understand about early retirement:
- You don’t need luck to retire early.
- You definitely don’t need a get rich quick scheme.
In fact, early retirement is no different from conventional retirement. The only difference is time.
The formula to retirement is to have enough passive income to cover your daily living expenses. As long as you don’t need to be actively working for money, and are receiving enough checks to cover your daily expenses you have enough passive income to retire.
How do you create passive income streams to facilitate your retirement income stream?
Path 1: Focus on your savings rate
Focusing on your savings rate is an option for everybody, and is the foundation for everything in retirement planning. The more you are saving, the faster you reach retirement or the bigger your nest egg. As we previously explained, your savings rate has direct impact on how long you need to work.
A common question about this path is… so will I be a millionaire if do this?
The answer is maybe.
What’s key to understanding your savings rate is that you are establishing a lower level of daily living expenses that you need to cover with passive income. Let’s take a look at a quick example:
Jordan, age 25, earns $100,000. Jordan has a goal to retire at age 35, so he commits to a 70% savings rate or saving $70,000 per year. Assuming he utilizes the appropriate strategies and invests wisely, he is on a path to retire by age 35.
Whether or not the sum of his savings in 10 years is $1,000,000 or not is not what is important. What is important is that his safe withdrawal rate covers his living expenses of $30,000.
Completing this math on a financial calculator can give you more insight into this, but the most important part to note is that you savings rate has a big impact on how long you need to save to cover your current lifestyle.
A commitment to saving at this level works great because you avoid lifestyle creep. Lifestyle creep is allowing your living expenses to increase as you receive raises and promotions versus pushing that money towards savings. As your living expenses increase, so does the amount of passive income you will need for retirement.
If Jordan wanted to spend $50,000 in retirement then he would need to change his savings rate or time period. Saving 70% of your income for 10 years won’t increase your lifestyle expenses in retirement unless you already have a substantial amount saved prior to your 70% for 10-year commitment.
Maybe your nest egg ends up at $1,000,000, but don’t worry about that number. Focus on your savings rate and you are on the path to early retirement.
Path 2: Use Leverage and the Tax Code
Path 2 starts by having a solid foundation of managing your spending rate. This is critical to understand.
To retire early you need to be a conscious saver.
If you cannot control how much you spend then Path 2 is no good to you. Stop reading now because it is likely worse for you than path 1.
Path 2 consists of business ownership and real estate. Specifically, the use of leverage and tax advantages behind these methods.
You may not need to save 70% of your income to retire in 10 years through these methods. Although, these methods are significantly more complex than path 1.
The best part of path 1 is that you are in 100% control of how much money you allocate to the various savings vehicles.
Business ownership and real estate are two areas you weren’t likely taught in school. Therefore, before embarking on path 2, you need to make the best investment in the world.
Invest in yourself. Knowledge is power.
In path 1, I assumed you were a W2 employee. However, you can use business, real estate, and a 70% savings rate to super charge your early retirement. None of these options requires exclusivity.
The biggest difference from being a W2 employee is the use of leverage and tax advantages from business ownership and real estate.
To learn more about the tax advantages check out how to pay less tax.
Leverage is an overlooked, yet extremely powerful force in your wealth building process. It allows you to move from trading your time for payment to trading your time for payments.
Two examples of leverage in business is leveraging other people’s time (ex: hiring an employee) and technology.
The primary example of leverage in real estate is financial leverage (using other people’s money).
Couple leverage with good systems and your real estate or business can be a money-printing machine even if your active involvement becomes less over time.
Not only do systems reduce the time you need to be involved, it is also proven to increase the value of the business. Providing the opportunity to sell the asset you created if you decide to sell.
Both of these options will require a significant investment in time, which may be above and beyond that of path 1. In path 1 you could remain a W2 employee where you go to work, enjoy your weekends, and save, save, save.
Using leverage and the tax code, you have an alternative path to early retirement.
Which path should you choose?
If you are ready to make a commitment to retiring early, you need to choose the path that best fits your skills and desires.
Both paths have trade-offs. Ultimately those trade-offs are worth it when your ultimate goal is to be financially independent earlier.
In the end, both paths require you to build assets. By not consuming today, you are buying freedom tomorrow.
If you are not sure what path to take today my advice to you is to make an investment in yourself. Build skills. Create a plan. Start today.
Do you want to understand how to make your money work for you and keep more of what you have earned?
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Nate Byers a Madison, WI CPA Financial Advisor, and all rights are reserved. Read the full Disclaimer in the footer below.