- The point of financial independence
is to have the financial ability
to leave work if you'd like at some point in the future,
early retirement is for
when you aren't earning a steady paycheck
through the traditional means of work
that we're all used to.
But to be able to retire early,
you need to be able to access your retirement investments
sooner than the age of 59 and a half,
because you'll need that money to live off of.
For example, if you are someone
who is going to retire at the age of 45,
then you've got roughly 15 years
where you have low to no income during that time.
So there's essentially one problem
that we need to solve for,
and that's how to access your retirement money early
without paying any penalties
or more money in taxes than you need to.
To make this possible,
you'll need to invest your money into specific accounts,
and sometimes even transfer that money
from one account to the other
so that you're in a position to be able to use that money
during early retirement before the age of 59 and a half.
In this video, I'm gonna break down that process
step by step for you.
As I go through each one,
I'll touch on the what, why and how.
Now knowing this is important
so that you don't accidentally invest
in a way that will delay your chances
of ever retiring early.
Hey, I'm Jarrad with an A.
And on this channel,
we talk about all things personal finance, investing,
and of course, financial independence.
This was honestly one of my biggest struggles
when first learning about FIRE
and it was extremely frustrating.
Obviously, I knew what to invest in,
and I knew everything about each type of investment account.
But which account do I invest in, when and why?
I could not get a straight answer from anywhere,
so I had to put the puzzle pieces together on my own.
So lucky for you, I already did all the work for you.
You're gonna want at least a basic level of understanding
for each account to really, really understand this process.
But even if you don't,
then this video will still be valuable
since it'll get you thinking about additional research
that needs to be done on your end.
I've already made some reference videos
that I'll mention throughout this one
to help you understand a little bit more.
All of those videos
will be linked up down in the description.
For the ones that I haven't created videos for yet,
then those will be released at some point in the future.
So for now, you can seek that info out on your own.
Three quick things that I have to mention
before we go too deep.
Number one, the strategy that I go through
is only for someone who is pursuing financial independence
with the intent of eventually retiring early.
If you're someone who is pursuing
their traditional retirement path
of leaving work after the age of 59 and a half,
then I created a whole video where I give you the roadmap
of how to invest your money.
Link to that video is in the description.
Like traditional retirement,
people will still get value from this video
because a lot of these strategies and tactics
might make sense to use,
but just not in the exact same way as someone pursuing FIRE.
Number two, this isn't the only way to invest
for financial independence, retire early.
The types of investment accounts available to everyone
is gonna be different.
This is just going to be an example
if you have access to these ones.
If you don't,
and you have access to something else like a 457 or a 403B,
then you can just substitute those accounts
that are available to you based on their restrictions.
And finally, number three,
I'm not a financial advisor or an accountant.
This video is for information
and entertainment purposes only.
Please, please, please, do your own research
before attempting any of this with your money.
Also, definitely talk to an accountant
before doing anything that I mention in this video,
so that they can help guide you through it
because some of these involve doing certain things
to optimize for taxes.
The first account you'll invest into
is your traditional 401k up to your employer match.
With their traditional 401k
your money isn't taxed at the time you contribute.
Same thing with your employer match.
The money your employer matches is automatically placed
into a traditional 401k and not a Roth 401k.
The reason you want to invest it into a traditional 401k
as opposed to a Roth 401K
is because you're going to use
something called a Roth conversion ladder,
after you leave work
to move money from the traditional 401k to a Roth IRA.
Doing this is going to give you access
to that converted money before the age of 59 and a half
without paying early withdrawal penalties.
With a Roth IRA, the money you contribute to it
can be withdrawn at any point in time.
The same thing goes with the money you convert
from a traditional 401k to a Roth IRA.
But there's two very important rules
that you need to know about a Roth conversion.
Number one, the IRS isn't gonna allow you
to get away with not paying taxes
when you put the money into a traditional 401k,
and then again, when you convert it to a Roth IRA.
They're gonna want their money.
So you'll pay taxes when you convert the money.
Even though you don't have control
over the fact that they weren't paid,
you do have control over how much they take
due to the tax bracket that you're in once you retire early.
When you contribute to the traditional
401k with pretax dollars,
we're going to assume that you'll be in higher tax bracket.
But once you leave that job,
your income will drop significantly,
which in turn will put you into a lower tax bracket
when you do this Roth conversion.
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The second rule with a Roth conversion is that
you'll have to wait five years
to access those converted dollars
without paying early withdrawal penalties.
So if you retire early at the age of 45,
and convert $30,000 from a traditional 401k to a Roth IRA,
then you'll pay taxes on that money upfront,
and you'll have access to that money at the age of 50,
because 45 plus five is 50.
If you're anything like me, then you're probably thinking
about the big elephant in the room,
and that's this five year waiting period
where you're not earning any money
and you can't access those converted dollars.
You obviously need money to live on during that time.
We're gonna solve that problem
throughout the remaining steps in this video,
so hang tight and pay attention.
I'll eventually have a standalone video
where I break down how to properly execute
a Roth conversion ladder in more detail.
Once that video is out,
I'll have it linked up in the description of this video.
Next, you'll max out your HSA.
This is gonna be one of the places
that you'll get money to spend
during those five years
you're waiting on your Roth conversion money,
and even beyond that.
I made a whole video breaking down how to invest in an HSA,
if you need more info
on everything you need to know about that.
I'll have a link to that video down in the description
or somewhere above my head.
You'll be able to access this HSA money
in two different ways.
The first is if you need to pay for medical expenses
between the day that you leave work and the age of 65.
You could just pay for those expenses
out of your current HSA balance.
The second way would be for medical expenses that you had
leading up to your early retirement date
that you paid for out of pocket.
Since you didn't pay for those medical expenses
out of your HSA at that point in time,
you're able to access these dollars
at any point in the future.
In the case you're going to wanna access that money
during early retirement,
this is a great way to pay for some expenses
while you wait for that five year
Roth conversion period to expire.
The next step would be to invest in an IRA.
Which type of IRA you invest in
is going to depend on your income.
The ultimate goal for this step
is to get your money into a Roth IRA
so you can use the contributions
during those first five years of early retirement
because as we know,
you can access your Roth IRA contributions
at any point in time without paying penalties or taxes.
If you're under the Roth IRA income limit,
then just contribute to that
then plan to use those contributions
during those first five years of early retirement
while you wait for that Roth conversion ladder to kick in.
But if you're above the income limit,
and you were only able to contribute to a traditional IRA,
then you'll need to complete
something called a backdoor Roth IRA
within the same year that you contribute
to move your money from your traditional IRA
to your Roth IRA.
The money you move from a traditional IRA
to a Roth IRA using a backdoor Roth
is considered a contribution.
So you'll be able to access that money immediately,
just like you would if you only invested
in a Roth IRA to begin with.
I'll eventually have a video
breaking this process down in the description.
But for now, you can look into it on your own
until I have that made.
You really, really need to understand
the rules around a backdoor Roth
because it's easy to screw up.
So please, please talk to your accountant
before doing anything
if you don't feel comfortable doing it on your own.
There's something called the pro rata rule
that you'll need to understand with a backdoor Roth.
I could make a whole video on the topic
so I won't break it down in detail right now.
Next, you'd wanna max out the rest of your traditional 401k
up to the yearly limit, which is $19,500 for 2020.
You'll plan to do the same thing you did
with the traditional 401k
and employer match money that we talked about
just a few minutes ago.
Once you leave work, you'll start moving this money
to a Roth IRA using a Roth conversion ladder.
Now, if you still have money to be invested,
then contributing to something called an after tax 401k
might be something that you wanna think about
investing in next.
From what I understand,
not all employers offer this account within their 401K.
But if yours does, then this would be how you'd utilize it
for early retirement.
Let me make something very clear before continuing.
You won't wanna even think about contributing
to an after tax 401k
unless you've already maxed out your traditional 401k.
For this type of 401k to make sense,
there's something you'll need to do
which we'll talk about in just a minute.
An after tax 401k allows you to invest up to $57,000 in 2020
within your 401k.
To figure out the additional amount that you can contribute,
you take the $57,000 then deduct
the $19,500 that you put into your traditional 401k
and also deduct your employer's contribution as well.
So if your employer contributed $6,000 for the year,
then we take $57,000 minus $19,500 minus $6,000,
which would make you eligible to put $31,500
into an after tax 401k for that year.
When you put money into an after tax 401k,
your money is already being taxed.
On top of that, it's treated like a traditional 401k,
so you're going to pay taxes
on the amount it grows two as well.
You're essentially getting taxed twice.
Once when you contribute,
then again when the money has grown
and you wanna withdraw it.
To any sane person,
this sounds like the worst place to put your money
just because you get taxed twice.
But hold on,
because you can do something called a mega backdoor Roth
to get around paying taxes when you withdraw.
I'm not gonna go into all the details
but at a high level,
this is where you contribute to your after tax 401k
then move the money ideally within the same year
into a Roth IRA.
Once the money is there in your Roth IRA,
it can grow tax free,
and you can withdraw the contribution amount
during your early retirement years,
just like you can with the normal
$6,000 per year contributions
that you put into your Roth IRA.
Two things I wanna touch on with a mega backdoor Roth.
Number one, to make this happen,
you need to check
with your employer's 401k management company
to make sure you are allowed
to do an in service distribution.
This will give you the ability to move money from your 401k
and into a Roth IRA while you're still employed with them.
And number two,
before you move the money from your 401k to your Roth IRA,
I'd suggest getting with your 401k provider
and the company you're using for your Roth IRA
to make sure that they're aware of what your plan is.
And of course, run this by your accountant as well.
Now the next two ways to invest
for financial independence and early retirement
are interchangeable based on your preferences.
The next place that you can put additional money
after everything we already talked about
is into your taxable investment accounts.
This is pretty straightforward to be honest with you.
I'd personally plan to sell off these investments
to use that money for living expenses
during the years between when I left work
and the normal retirement age of 59 and a half,
and especially during that five year waiting period
when it comes to the Roth conversion ladder.
Next, set money aside to purchase cash flow in real estate.
This can technically be done anywhere throughout these steps
that we talked about already.
The goal with this would be to build up enough cash flow
coming from rental properties
that the money could supplement some
if not all of your monthly expenses in early retirement.
To give you an idea of what I'm doing,
I personally stopped putting money into investment accounts
after maxing out my 401k and IRA as well.
The additional money that I have left over
is going towards real estate investing
so I can build some of that cash flow for myself
whenever I decide to retire early.
As amazing as I think real estate investing is,
I understand that it's not for everyone,
so don't feel obligated to do it.
Watch these financial independence videos to your left next.
Make sure to Hulk smash that thumbs up button.
Check out the description for more resources and playlists
to help you out with all of your personal finance,
investing and financial independence needs.
I'll see you in the next one friends, adios.