3...2...1...The Countdown to Financial Freedom
Regardless of what retirement looks like in your dreams, the best way to live out those dreams is to make a plan for financial freedom.
Financial freedom is that point at which your work becomes optional.
Here is a three step process to help you get closer to financial freedom.
Step 1 - Organize your retirement assets
Put pen to paper – or open Excel – and list each of your investment-type assets. These should include assets in your retirement accounts and assets earmarked for retirement outside of your retirement accounts:
Cash
Investment accounts (Stocks, Bonds, Mutual Funds and ETFs)
Cash value life insurance
Practice Value (assume 90% of annual collections)
Investment real estate
Do not include your primary home or personal property.
Then create a sub-category that groups them according to their tax treatment. That means anything held in:
Any accounts outside of retirement accounts in a brokerage account would be classified as taxable.
Any traditional retirement account, such as a traditional IRA, 403(b) or 401(k), would be labeled as tax deferred.
Any accounts in a Roth IRA or Roth 401(k) would be categorized as tax-free.
Tax treatment is important because assets subject to taxes can be worth less in retirement than assets not subject to taxes. Assets in a ROTH are usually considered the most valuable because their qualified distributions are tax-free, while assets in a taxable account are next in line because they potentially qualify for favorable long-term capital gain tax treatment. Assets in a tax-deferred retirement account come in last because you pay taxes at ordinary income rates when you withdraw money in retirement. In addition, when you turn 72, you must take a required minimum distribution from your tax-deferred retirement accounts whether you need that money or not.
Step 2 - Determine your retirement goals, needs and wishes
If you don’t know where you’re going, then it will be difficult to determine how to get there. What do you see yourself doing with your newly discovered free time in retirement? Continue to work part-time in dentistry? Turning a hobby into a business? Spending more time on your hobbies? Traveling? Seeing family?
Also, where will you be living? Will you have two homes? Will you downsize, upsize or just move? Or maybe you will hit the road in a Sprinter Van or live on a houseboat.
Finally, the toughest question: How long might you live in retirement? What’s your family history? How do you take care of yourself? It’s time to consider longevity and while no one knows how long they will live, it helps to have a target. We commonly plan for clients to live into their 90s. It’s much better to overestimate how long you might live than underestimate.
Step 3 - Make a plan on how to get from what you have to what you want
Now that you know your starting point and have an idea (even if vague) of where you want to end up, the next step is creating a lifelong income plan. This process starts with estimating the pre-tax income you will need for annual retirement income . This can be easier said than done, but a good starting point is using 70% of your current income.
Now that you know your “approximate” income needs, list the income sources that you can count on. These include Social Security, annual withdrawals on retirement accounts (3% of balance is new standard), any defined benefit pensions, part-time work, etc. That will help you figure out what gap exists – if any – between the income you need and what you’ll have. If, for example, your estimated need is $8,000 a month and your Social Security and part-time work income is estimated at $7,000, you have a $1,000 gap to fill.
Once you’ve determined your income gap, you will need a plan to fill that gap. While there are many investment options and strategies available, the key is to invest early and often to ensure that gap can can be closed as you track towards financial freedom.