Want to Retire Early? Try This. (+All Your 401k Questions Answered)

APPLE | SPOTIFY | STITCHER

Since leaving my 9-5 and not having a formal job, many people have been asking me lately where our money comes from - I mean, we still have a mortgage to pay and, in Austin, Texas, that is no small bill.

And, if you know me, you know I'm going to say our money "comes from our investments," but I thought today it would be great to dig a bit deeper into what exactly that means for us, and how Cory and I were both able to "retire" by age 30.

Today we'll cover:

All your favorite retirement acronyms (401(k), IRA, ROTH + Rollovers), plus the single biggest mistake I see people making with these
My story and how I retired from my corporate career in 10 years
A different way to think about money that just might change everything for you

When researching for this episode, I looked up the definition of retirement and, as you can imagine, it varies... but if I had to pick one, I'd choose Merriam-Webster's, which is: withdrawal from one's position or occupation or from active working life.

A few of the other definitions made me laugh out loud, this one in particular that says retirement is: the act of leaving your job and stopping working, usually because you are old.

Although it makes me smile, I think it's important to point out that this definition raises a common misperception about retirement - which is that you have to be a certain age to do it. In the US, that might stem from the fact that you can't access your 401(k) retirement funds without penalty until you're nearly 60, but we'll get to 401(k) and other retirement accounts in a little bit.

You can retire whenever you want, regardless of age and regardless of semantics - it really just means you've reached the point when you can stop trading your time for money because you can now live off your savings and investments.

Furthermore, your retirement funds can come from places beyond just your 401(k) or your IRA... and, in my opinion, they should. As with the investments themselves, I believe in diversifying where you hold those investments. So let's get into the details, starting off with answering all your 401(k) and IRA questions.

401(K) VS. IRA - AND WHAT'S "ROTH"?

If you're from the US, it's likely that one of your main associations with the word retirement is a 401(k) and/or an IRA... and maybe you've also heard the word ROTH before, too.

Honestly, this is one of those financial holes it's easy to go down quickly, so for today's purposes I'm going to keep things at the overview level.

So, at the highest level, a 401(k) and an IRA are both retirement investment accounts; to help you remember this, IRA stands for Individual Retirement Account... the 401(k) name is less fun because it comes from an IRS code. But the way I like to think about both of these accounts is that this is money I can't really touch until I'm about 60 years old because, if I do, I'll face a huge fine.

In other words, if it's an emergency and you absolutely need to pull money from either your 401(k) or your IRA, you CAN, but it'll cost you big time... and the reason why is because these plans are set up to incentivize you to put money in them and leave it alone so it can grow until you're about 60 years old, when most people retire.

401(k)

The main difference between a 401(k) and an IRA is that a 401(k) is an employer-sponsored retirement plan, so the only way to get a 401(k) is to get it through an employer, whereas anyone can go set up an IRA.

If you work for an employer, it's important to know if they've got a 401(k) and, more specifically, if they offer a contribution match. This is a benefit many companies offer their employees where if you put a up to a certain percentage of your paycheck into your 401(k), your employer will match that by putting in the same dollar amount.

When I was in corporate, that percentage was typically around 4-4.5% but it can vary. So, for easy math, let's say each paycheck you get paid $1,000 and your employer offers a 4% match. That means if you contribute 4% of your $1,000 paycheck every month, which comes out to $40 per paycheck, then your employer will ALSO put in $40 of their money into your 401(k).

But if you decide you're only going to put in $30 per paycheck, that means your employer will also only put in $30... which means you're missing out on $10 per paycheck for free from your employer each time you're paid.

And while that may not seem like much, in this example, if you were only getting paid once a month, missing out on that $10 from your employer would result in a loss of $25,000 in retirement (and that's assume slightly-below-average market performance).

It's likely that you get paid more than $1,000 per month, and it's likely the market will perform at least average, so this number will only go up.

My point is: if your employer offers a 401(k), it's worth it to make sure you're contributing at least as much as their match.

IRA

With an IRA, anyone can set this up because it's not employer-sponsored. You can even set this up IN ADDITION to your 401(k), if you want, but really the only reason you'd need to do that is if you were reaching the maximum contribution limits in your 401(k) and wanted to contribute even more to a retirement account, in which case you could put in additional contributions into your IRA.

But, let's be honest, I don't think many of us are going to have an issue maxing out our 401(k) contributions... I believe the current maximum contribution amount for a 401(k) in 2022 is $20,500 and, if you're over the age of 50, you can put in an additional $6,500. And to keep you on your toes, this max limit changes every year.

So, in my opinion, generally you should really only consider an IRA if your employer doesn't offer a 401(k)... unless you're making bank and are maxing out your 401(k) or are so good at picking stocks and are looking for options outside of your 401(k) options, in which case THAT'S AMAZING, but I'm not sure my podcast is going to be helpful for you because you probably already know more than I do.

So, again, for my listeners, you probably really only need to consider an IRA if your employer doesn't offer a 401(k), or if you're self-employed or in some other situation where you don't have access to a 401(k) and you need a place to put some money away that you can't touch for awhile.

If you have fantastic self control, then you might not even need an IRA at all... you can invest in other assets that you can access much sooner than age 60, but if you know yourself and you want to put at least a little bit of money into an account that you pretty much can't touch until later in life and you don't have access to a 401(k), then definitely explore an IRA.

For me, all my full-time employers have offered 401(k) plans with a match, so I just took advantage of that and never really saw the need for an IRA, however, I'm actually currently in the process of opening my first IRA because one of the investment companies I have one of my 401(k)'s at is discontinuing their 401(k) program, so I need to find a new home for that money and, since I don't work for an employer who offers a 401(k) anymore, I'll need to open an IRA in which to place that money so I don't get hit with that big tax penalty I've been referencing.

In other words, if I did nothing before the investment company shut down the 401(k) program, they'd pull out my money and send me a check in the mail, and if I didn't put it into another 401(k) or IRA pretty quickly, I'd get hit with the hefty tax penalty... which is why I'll be putting that money into an IRA.

Rollovers

Which brings me to my next point - rollovers. This is essentially what I'm in the middle of right now: a rollover. Usually the only time you'll need to consider a rollover is when you're switching jobs and, the main function, is just to keep everything in one place so it's more organized.

So, instead of having one 401(k) with your former employer, and one 401(k) with your new employer, you can ask for a rollover which means the money from you former 401(k) will be moved into your new 401(k) at your new employer's provider.

I love the idea of doing this to keep things organized but, unfortunately, as with a lot of finance things, it's not always that simple. It's good to think about what's important to you, and see if you're better off rolling over or keeping things separate.

Again, organization is my middle name so I'd LOVE to have all my 401(k) accounts together in one place, but for example, one of the benefits I received at Cisco, one of my previous employers, was that they worked out a really great deal with a company called Financial Engines who manages my investments for me (in other words, they pick the actual stocks that my money is invested into inside of my 401(k) because I'd rather a trained professional do it for me for a negligible fee).

As I'm going through my current rollover process, I looked into rolling over that old Cisco 401(k) and consolidating all my retirement accounts so things are just easier and more organized... but the rate at which Financial Engines is managing my money because I was a former Cisco employee is literally 7 times cheaper than anything else I can find... so, therefore, I'll be leaving that 401(k) where it is.

An easy way to think about all of this is: it's sort of like having multiple bank accounts... at the end of the day, it's a lot easier just to have all your money in ONE bank account, however, if you're getting certain perks by having your money spread across two bank accounts, then it might be worth the extra hassle.

ROTH

Now, real quick before I get to the most important point of all about retirement accounts which I really, really, really want you to hear - real quick before that, let's discuss ROTH.

So, before getting to ROTH, you thought you just had to chose between a 401(k) and an IRA... but there are actually two types of each of those accounts. You can choose between a:

Traditional 401(k)
ROTH 401(k)
Traditional IRA
ROTH IRA

The easiest way to think about this is that, in the case of both 401(k)'s and IRA's, the traditional option means you pay taxes later (i.e. when you take your money OUT OF your retirement accounts), and the ROTH option means you pay taxes now (when you put money INTO your retirement accounts).

I know it's really tempting to just pick traditional and pay taxes later, but I think this deserves just a little more thought... specifically, if you pay taxes NOW, will you spend less on those taxes than if you pay taxes LATER?

Look, no one has a crystal ball, but I'll tell you the reason I currently only invest in ROTH... it comes down to 2 things, one of which is in my control, and one of which isn't:

My income level - which I feel is mostly within my control
Tax brackets - which are not in my control at all

When it comes to our income, it is my true belief and intention to continue growing our wealth more and more each year through investing in income-generating assets... which means, later in life, we will be in a higher tax bracket. Therefore, it's smart for us to go ahead and pay taxes now at a lower rate.

When it comes to the tax brackets, this is out of our control, but historical data can at least offer a bit of insight. Based on one article I read today, the average total top income tax rate from 1913-2022 is about 53% (again, I keep an eye on the highest tax bracket because that's where we aspire to be when we're taking money out of our retirement accounts).

Today, in 2022, the highest tax rate is 37% (which is 16% lower than that average) so this feels like another reason to go ahead and pay those taxes now.

Some of you might be thinking: but what if you put that money in the stock market, instead of using it to pay taxes... and if you're thinking that, I really like where your mind's at because I thought the same thing.

The reason why is because, historically, the stock market returns an average of 10%... and 10% is lower than the 16% I just mentioned.

Again, this isn't a perfect science and no one can tell the future, but with the information I've got, this is how I made my decision and I hope it helps you better understand ROTH versus traditional 401(k)'s and IRA's, and I hope it helps you make your decision on where is the smartest place to put your money.

*****THE MOST IMPORTANT THING*****

The absolute most important thing is to make sure the money you're putting into your 401(k) and/or your IRA is ACTUALLY INVESTED and not just sitting in a brokerage account.

Let me explain what this means. Investing in your retirement accounts - or in the stock market in general - is, in it's most basic form, a TWO-STEP PROCESS.

The first step is to put money into your brokerage account (which is basically like a bank account but, unlike your banks, brokerage accounts give you access to the stock market and other investments)
The second step is to move the money FROM your brokerage account INTO the investments (or, in other words, to actually buy the stocks)

This is a mistake I unfortunately see people make all the time and it's CRITICAL because if you're not actually invested, you could potentially lose out on hundreds of thousands of dollars over the course of your life, depending on how much you've got in your brokerage account, how long it's been just sitting there doing nothing, and where that money could have theoretically been invested.

Think about it this way... this is one of my favorite analogies.

Think of your retirement account as Disney World. If you're at Disney World, you're probably there to ride some rides.

In order to get to those rides, you'll need to enter one of the theme parks, get in line, and eventually you'll have made it onto the ride, cruising around with the wind in your hair.

The theme parks are like brokerage accounts... and the rides are like the investments. In the same way that you can't actually get to a ride without first entering the theme park, you can't actually buy investments through your retirement account without first putting your money into a brokerage account.

Sure you could show up to Disney World, and go to one of the theme parks and just hangout at a picnic table. And if your money isn't actually invested, that's pretty much what you're doing.

But if you're looking for the full experience and you actually want to see your money grow through the power of investing in your retirement accounts, you need to make sure your money is on the actual ride.

So TODAY I want you to go look in your brokerage account and make sure your money isn't just sitting in there; make sure it's actually invested. If you need help, ask your HR department or call your 401(k) or IRA provider directly.

HOW WE DID IT

You may have heard this story before, but I'd like to quickly recap the moment I realized retiring early was available to me (or anyone) and the valuable advice I received that helped me pull it off in 10 years.

In 2013 I was working my first job out of college where I was navigating, what were for me at the time, the choppy waters of personal finance.

I was investing as much as humanly possible into my 401(k) (which, for the record, I don't recommend if you're trying to retire early, because you can't get to that money until you're 60 years old, but I was doing that because I thought that's what you were supposed to do).

And, furthermore, because all my extra income beyond my living expenses was going to my 401(k), my bank account was never super high so I'd just recently finished dealing with an unexpected car repair that nearly sent my bank account to $0, and ultimately resulted in me breaking down into tears in one of my manager's offices...

Definitely not the definition of stress-free finance, right?

Well, it was around that time that I received an email that said: "Please Join Us to Celebrate Melanie's Early Retirement!"

"Wait a minute," I said to myself, "I thought you had to be 65 to retire."

I was confused. So I attended her early retirement party. I sulked around and picked at the fruit tray and suspiciously side-eyed the cake that read: "Congratulations, Melanie!" And I was generally more antisocial than normal, lost in my thoughts on just how in the heck she was doing it.

I thought you couldn't even access your 401(k) until you were 60? Where's she going to get money? Doesn't she have bills to pay? I had a lot of questions. So I set up time with her get answers. I walked into her office, made some pleasantries, then point-blank asked: "How are you retiring early?"

And here's what I learned.

After receiving all this advice from Melanie, I immediately reduced my 401(k) contribution amount to the lowest I could without leaving anything on the table (so I reduced it from 14% down to 4% so I could take full advantage of my employer match), and I saved that 10% difference until I had 6 months worth of living expenses saved up in an Emergency Fund so I'd never have the stress I felt when dealing with my unexpected car repair ever again.

And, while I saved, I looked for smart places to invest my money once my Emergency Fund Goal was reached.

In my blog post How I Quit Trading Time for Money you can see my specific 10-year timeline and key decisions Cory and I made to make sure our money grew as much and as quickly as possible.

The summary of the big 5 things is this:

Reduced 401(k) contribution to lowest amount I could while still receiving full employer match and I put all the extra money toward an Emergency Fund (6 months of living expenses)
After reaching our Emergency Fund goal, if we had had any debt with an interest rate of higher than 10%our next step would have been to pay that off as quickly as possible, but the only debt we had were my student loans and the interest rate was lower than 10% on those, so I made the required payments on my student loans, but no more because we knew we could probably make at least 10% if we put the extra money in the stock market... which is exactly what we did:
We put all the extra money, including any bonuses and raises, into investments in the stock market through a fiduciary, which are companies legally required to put the welfare of your money ahead of their interests
We used those investments to buy a house and used that house to create cash flow until it appreciated, at which point we sold it and we reinvested the money into a variety of different assets like paper assets, commodities, our businesses, real estate in El Salvador, and crypto.
Throughout all of this, I made sure that every single year my salary went up and as I matured, I got more intentional about negotiating raises especially when switching employers because research shows this is when you're best positioned to get the highest pay bumps

I want to highlight this last point because I think it's worth the emphasis because, in addition to having the right mindset, I think increasing your pay rate is one of the most important things you could possibly do if you want to retire early.

It's true that investing is absolutely the key, but in order to invest, you have to HAVE the extra money available to invest. And while I'm all for cutting expenses, there's really only so many costs you can cut. Your pay rate, on the other hand, is essentially uncapped - so while cutting expenses may be easier, getting a raise is much more efficient and effective, assuming you put all that extra money into investments.

If you are serious about getting a raise, I just did what was essentially a mini-series on how to do that so be sure to check out Episodes 5, 6 and 7.

I'd like to acknowledge how uncomfortable it was to set up this meeting with Melanie and to ask this question. Money is such a taboo subject in our culture, which needs to change because the more we talk about it the more we learn - which was probably my biggest learning of all from this experience.

As I say often, this conversation changed my life forever, and had I not pushed past the fear I felt when I considered asking her advice, I never would have received her valuable input.

So, ask questions. Seek guidance. Find mentors. Talk about money. And do it now. A year from now you'll be glad you did.

FIRE: FINANCIAL INDEPENDENCE, RETIRE EARLY

If you're sitting there listening to this and taking an honest look at yourself and your spending habits and you feel concern over being able to reel in your spending, or about getting a raise or a bonus and not having the self control to put it all in investments - you are absolutely not alone.

Most people do not have this discipline. Which is why you don't see most people retiring early.

It's an uncomfortable truth, but I'm here to give you some tough love because the reality is: if you want something different than most people, you have to do something different than most people.

And I used to be exactly in your shoes, but something that really helped me is the concept of FIRE from the book Your Money Or Your Life by Vicki Robin and Joe Dominguez, which stands for Financial Independence, Retire Early.

You can read more about this online, but the key lesson I took away from FIRE is to STOP thinking of purchases in terms of dollar amounts, and START thinking of them in terms of hours of my life.

Think about it: you go to work to get paid, right? Be honest: if they didn't pay you, would you do work for them? Probably not. So you are trading hours of your life for money.

So let's quantify that.

As an example, let's use the average salary in Austin, which is $67K. Assuming you work 40 hours per week and get 2 weeks off a year, that means you're getting paid $33.50 per hour.

So, instead of browsing Amazon and mindlessly adding items to your card, tapping three buttons, thinking "Oh, this shirt is only $30" try thinking to yourself... "Do I want this shirt bad enough to work an hour at my job for it"?

This becomes even more effective at a higher scale... think about a car payment. The average car payment in the US in 2022 is over $700 per month. At the $67K average salary range, that means every single month you're trading 21 hours of your life, so nearly 3 full days of work per month, to own that car.

The average car loan for a new car is nearly 6 years... so when all is said and done, you'll have spent 189 days at work paying for this car... that's over 6 months of your life at your job SOLELY paying for this car... nothing else.

If I were to tell you that for the next 6 months you had to go to work, but you wouldn't be receiving a paycheck because I'd be paying your car lender directly... would you agree to that? Is that new car worth that to you?

And, look, I realize many of us need cars; I'm not saying don't buy a car. I've had a car since I turned 16, but I've never had a brand new car and I don't ever plan to because it's not worth trading that many hours of my life for... I'd rather invest that money and have it grow so I can have even more time freedom than I already do.

So what I'm trying to say is this: when considering every expense, especially the big ones, start thinking of these things in terms of how many hours of your life it's going to cost you... and then decide if it's worth it.

THE BIC PICTURE

Whether you're in your 30's and want to retire by age 40, or if you're older than that and your goal is to retire before the 'norm', with the right mindset, discipline, and regular pay increases, it is absolutely available to you.

Get your hands on the free resources below, and start taking action today.