As we go throughout our 20’s, 30’s, 40’s and so forth, especially if we are working for an employer, we are constantly told to invest in our retirement accounts through the Individual Retirement Accounts (IRAs).
Then came 401k retirement accounts, through your employer, and Health Savings Accounts (HSAs). The H.S.A. could also be through your employer, for extra financial benefits.
These 3 retirement accounts can all be had, via pre-tax. However… what if you wanted to be financially free, sooner than later? What if, instead, you go all in on the taxable brokerage Account?
Maximum Amount per Account
To start, we really need to breakdown the maximums you can contribute to each plan on an individual basis (not family for the H.S.A., to keep it consistent!).
First, the Individual Retirement Account (IRA). We won’t go into the Roth, we will focus on the pre-tax, traditional IRA. For 2023, under 50 years old, you can contribute $6,500, pre-tax, into your traditional IRA.
Second, the 401(k) through your employer. Similarly, the maximum pre-tax 401(k) amount in 2023, for a single person under 50, is $22,500.
Lastly, the Health Savings Account, also through your employer. The maximum in 2023, for a single person under 50, is $3,850.
In total, that is $32,850 to be invested into pre-tax investment accounts potentially in a single year.
Let’s be honest, that is quite a bit of earnings that you are allocating to pre-tax investment based accounts. It’s phenomenal and if you are able to do this, heck yes and many of us will applaud you!
What’s a big benefit of doing this? The tax savings, of course.
pre-tax investing – the tax savings
To also stay honest, the main reasons why we are doing this is the tax benefit! That $32,850, at a tax rate of 22%, is saving you $7,227 in tax dollars or $602.25 per month! That is serious cash, as well.
We can also conservatively estimate that is also $1,000 in state tax savings and – if you do your H.S.A. through your employer, that is an additional $295 in tax savings. We won’t even consider that in our discussion here.
Keep in mind, most of the accounts for pre-tax are untouchable until 59.5 years, with a few deviations with the H.S.A. account. Let’s say you do this for 37 years. That could equate out to, at a 7% growth rate, to be $5.434,005 by the time you are 59 years old, if you start this at 22 years and all other items remain constant.
At that point, your income is $190,000 per year when applying a 3.50% dividend yield on that amount.
In addition, each month you have an extra $600 in tax savings that can help fund your monthly expenses OR that you can also invest back into the market if you are a super extreme saver.
So at 59.5 years young, you are looking at a really nice retirement for maybe 5, 10, 15, 20 or even 25 years if you are lucky. Not too bad, right?!
That’s not why you are here though, possibly. You are here because you want to be retired earlier. You want freedom faster. What if you didn’t use the pre-tax account, as you want everything to be accessible without having to do any conversions or mega-back door Roth Conversions.
Math behind going all taxable
Again, let’s say, for argument sake, you are able to live off of $2,000 per month and you pay $2,000 per month in taxes, and you are investing $2,737.50 (i.e. $32,850) per month. At that rate, you are making $80,000-$81,000 per year.
You do this for 18 years, age 22 to age 40, again wage and all items stay the same. You invest the $2,737.50 per month for 18 straight years, here is where you would be with a 7% return rate:
$1,152,263 is nothing to sneeze at! In fact, that sends out $40,000 in dividend income, at a 3.50% dividend yield. Which, as you re-call, you are used to living off of $2,000 per month. Earning $40,000 per year in dividends is $3,333 per month AND is taxed far differently. It would actually be tax free if that was your only source of income. Earning $40,000 in dividend income could be close to the equivalent of earning $61,500, if you pay ~35% in taxes.
Life is pretty good, you are able to enjoy a decent lifestyle for the most part. What happens, though, over the next 19 years, until 59.5? Therefore, in the calculator, we input the $1.152M you have and do not add anything and let it compound from age 40 through age 59.5.
You do not end up at the $5.4M, from earlier, but you still do end up at $4.167M! That would produce a dividend income total of $145,000 at an average dividend yield of 3.50%, which is definitely doable!
the point – financial freedom
Now here is the drilling point to everyone reading this. Financial freedom is DEFINITELY possible. However, it is still not an overnight path or journey. Heck, Bert & I have been writing on this blog for almost 10 years and we are not financially free yet. If we use the same plan above, we still have many years ahead before we get there.
If this was easily achievable in 1, 3, 5 years – everyone would be financially free and the now hiring signs would be more prevalent now than ever. That would just be too easy. However, this is not easy. You have to have a high savings rate for a long period of time and frequently check in on your income and expenses, each and every month, more than likely.
It is possible. Financial freedom can be achieved at all levels of the spectrum. If you are making $80,000 per year, you have a great chance of being able to retire decades earlier, still. I have seen people make far less and becoming financially free, sooner! However, I wanted to provide that it is possible and you can achieve it without retirement accounts essentially.
Are there other variables? You bet. It can be your tax bracket, that may be different. Your personal living situation, could be drastically different. Unknown with what a person does with their tax savings can change the direction of a portfolio as well.
To put it in further perspective – I’ve been in the workforce almost 12 full years, full-time. You can see at our dividend stock portfolio page, the value and size of my personal investment account. I know I’ll be financially free, but it really is up to father time to catch up!
I have since debated about stopping the retirement account investments and then swinging it all for a year or two directly into the taxable account, to really propel the ability to retire sooner, faster!
What do YOU think of this analysis, retirement vs. non-retirement accounts and the timeline of being financially free? What is your take and how are you approaching the journey to retiring early off of dividends? Please share in the comments below. As always, good luck and happy investing!
-Lanny