The Three Stages of Financial Independence for Young Lawyers

Becoming financially independent is the one achievement almost all our clients say they aspire to – but what does that actually mean? The reality is it can mean different things to different people.? Here are some thoughts on what I consider the 3 stages of financial independence.

When discussing retirement goals and financial independence with new and prospective clients, the first questions I get asked most often are, “How much do I need to save?” and, “What do most people have (saved for retirement)?”? It’s almost as though people think there is a magical, one-size-fits all number that, once achieved, puts them across some finish line from being financially?dependent to financially?independent.

The reality is that there is rarely a single number that indicates someone has reached the holy grail of financial independence.? It, like life itself is a constantly moving target.? As one’s life and lifestyle changes, so too does the amount required for them to reach financial independence.

When having these financial independence discussions, I am also often asked, “well, how much do you need (many people will ask very personal questions of me)?”? Regardless of my financial goals, my number is most certainly guaranteed to be different from yours. Your tastes, habits, and expenses are different from mine. We don’t have the same family. We didn’t start in the same place.? This makes having one, universal number very difficult.

Instead of thinking of financial independence as some, one-time goal, think of it as a continuum with multiple stages.? Here are the three main ways I think about financial independence and how I plan to reach each stage. But, regardless of the three different stages to financial independence, they all have one basic thing in common: You don’t have to work to earn an income because your investment income covers all your living expenses.

Stage One Financial Independence: Median Household Income

The median household income in Canada is $70,332. The poverty line for a family of two is $33,140. If your family is making between $33,140 and $70,332, you are in the lower middle class by definition (although it’s debatable that we should be using the concepts of “lower middle class” and “upper middle class” but that’s a story for a different article).

It would take somewhere between?approximately $828,500 and $1,760,000 in savings to reach Stage One Financial Independence?assuming you could withdraw about 4% of the portfolio without ever need to touch the principal. This level of savings would provide you with an?income?level in the lower middle class (keep in mind that it’s really your expenses that count, which we will soon see, but approximating the median income seems the best measure for Stage One Financial Independence since at this income level there’s not a ton of room for saving money anyway).

If you had an income in this range you would be able to cover all of your annual expenses in the majority of the country. Your lifestyle might be lower than it is today – and you probably wouldn’t be living in a big city – but you would no longer need to work to cover your basic living expenses.

In my view,?Stage One Financial Independence is achievable by 99% of lawyers. The speed at which you obtain Stage One Financial Independence will depend on your income but the end result is simply a matter of?when?and not a matter of?if, assuming that you decide to achieve it.

A lawyer that saves $10,000 a year over a 35-year career (from ages 30 to 65) can expect a nest egg of $1,480,000 in today’s dollars (assuming a 7% avg rate of return for the period). I don’t know too many lawyers that can’t save $10,000 a year. If that same lawyer manages to increase her savings rate to $20,000 per year for years 40 to 65 she’ll end up with $2,150,000, putting her expected retirement income ahead of the current Canadian median household income.

Many lawyers aren’t able to grasp Stage One Financial Independence because they either grew up in expensive areas of the country or are working in expensive areas of the country right now. If you have a portfolio of $1,000,000 generating $40,000 a year in income, it might seem far-fetched to imagine living off $40,000 a year in a city like Toronto or Vancouver.

Stage One Financial Independence has a lot of flexibility though and is the most important stage of financial independence since it’s the baseline level where you can call yourself financially independence.

Once you reach it, you can do things like:

• Decide to work at a non-profit for a tiny salary.
• Explore a risky side-project or business and not worry about it failing.
• Downsize by moving into a small house or apartment and stop working entirely.
• Move to a lower cost-of-living location in Canada or somewhere else in the world where you can stretch each dollar farther.
• Take a multi-year sabbatical to travel the world or spend time with your children between ages 0-5 before they start school.

Stage One Financial Independence is where a BigLaw Associate can find himself after 5-8 years of working. Or, for a household in New Brunswick, it’s where they could find themselves after 15 years of saving $30,000 annually (expected portfolio at that savings rate would be about $800,000). For that New Brunswick lawyer, neither partner would likely even need to maximize their RRSP contributions to reach $800,000 since $30,000 a year is likely less than the maximum space available to them each year.

Stage Two Financial Independence: Current Expenses Covered

If Stage One Financial Independence is the result that 99% of lawyers can expect to achieve in their lifetime, Stage Two Financial Independence is the outcome that confuses them the most. Many lawyers assume that because they’re in their working prime, they’ll never be able to achieve “true” financial independence where investment income is covering their?current?expenses. Those lawyers forget that they could easily move to other parts of the country and be financially independent.

But let’s dream a little and imagine how much money it would take to cover your current expenses. If you follow the 1st Year Sample Budget (contact us if you’d like a copy) we utilize with our clients you’ll be spending about $72,000 to live in an expensive city. You’ll also probably be living with roommates, so we’ll call this the low end of Stage Two Financial Independence (note that it’s still higher than the Canadian median salary). If you’re a family of three living in Toronto, however, it’s reasonable to think your expenses could be closer to $120,000 a year.

It would take somewhere between?approximately $1,800,000 and $3,000,000 in savings to reach Stage Two Financial Independence?assuming you could withdraw about 4% of the portfolio without ever needing to touch the principal. This level of savings would provide you with enough income to cover expenses in a big city.

The funny thing about Stage Two Financial Independence is that it’s still a perfectly reasonable goal attainable by the majority of lawyers willing to work their entire career.

A lawyer who starts early by putting $1,000/month into their RRSPs from age 30-35 then is able to max out the contributions (will just assume a static contribution of $31,560 even though the max is set to increase annually) from 36-65 could expect a nest egg of over $4,000,000 by 65. Many lawyers simply don’t want to work for 35 years but, if you’re willing to do so, it’s perfectly reasonable to expect to reach Stage Two Financial Independence. If you add a TFSA to that savings plan, you could come out with almost $4,800,000 in total retirement savings, putting you at the upper range of Stage Two Financial Independence.

I think a lot of lawyers find themselves defeated thinking about Stage Two Financial Independence because the thought of working for 35 years seems like too much. Can you reach Stage Two Financial Independence earlier in your career?

If you’re willing to save $50,000 a year toward retirement (in RRSPs, TFSAs and non-registered investments, you could cut that working career nearly in half by working from ages 30 to 48 and you’d have a retirement account of almost $2,000,000, putting you in the beginning bands of Stage Two Financial Independence.

Saving $50,000 a year towards retirement is a “serious” savings mode, which may be too steep for many (keep in mind this in addition to any other saving you need to do for things like houses, cars, etc.). But it’s certainly possible to reach Stage Two Financial Independence in an early timeframe if you’re motivated. If you have a combined household income of $200,000, saving about 25% of your gross income would put you on course to save $50,000 a year.

Stage Two Financial Independence gives you even more flexibility than Stage One. Once you reach it, you can do things like:

• Stop working entirely, continue living in your current city and spending the same as you have been previously.
• Move to a lower cost-of-living location in Canada or the rest of the world and live like a king, never needing to work again.
• Explore a risky side-project or business and use some of your capital to help get it off the ground.
• Have one spouse stay at home permanently while the other spouse pursues other hobbies or interests.
• Become an artist without ever being concerned about selling your work.

Stage Two Financial Independence is where a super-saver lawyer in big law might find themselves as a junior partner. Or, for a household in Moncton, it’s where they could find themselves after 35 years of saving $24,000 annually (expected inflation-adjusted portfolio at that savings rate would be $3,000,000). For that east-coast lawyer, that likely doesn’t even involve having to max out their RRSP and TFSA every year during a normal 35-year working career!

Stage Three Financial Independence: Ideal Expenses Covered

This is the level of Financial Independence that everyone wants to achieve. It’s also usually what someone has in mind when they first discover the concept of financial independence. A typical example is a lawyer that decides if they had $200,000 of annual income – without needing to work – they’d be all set. With $200,000 – $300,000 in income, you can live comfortably as a family of four in just about anywhere in Canada or the world.

It would take somewhere between?approximately $5,000,000 and $7,500,000 in savings to reach Stage Three Financial Independence?assuming you could withdraw about 4% of the portfolio without ever needing to touch the principal.

This level of savings may feel out of reach for most lawyers unless they’re willing to sacrifice a significant amount of current consumption for future consumption. A lawyer saving $40,000 a year towards retirement that is willing to work a full 35-year career could expect to have a nest egg of $5,000,000. To bump themselves to the higher end of the range they’d need to save $60,000 a year.

Does this mean Stage Three Financial Independence isn’t attainable? I don’t think so.

The way many people reach Stage Three Financial Independence is through a combination of investment income and investment cash flow acquired later in life. The thing about Stage One or Stage Two Financial Independence is that if you’re motivated enough to reach them fairly early in your life (i.e. before 45), you’re likely the kind of person that will find other ways to generate money in retirement.

Since financial independence allows you unlimited time to pursue whatever you want, many people move up the stages of financial independence once they’re unshackled from working on projects and tasks that benefit someone else more than they benefit themselves.

If you had unlimited time and had reached Stage One Financial Independence, would you be motivated to push yourself toward Stage Two or Stage Three?

What stage of financial independence are you aiming for? Let's talk about it. We can help you determine what you need to achieve each stage and, more importantly, create and implement a plan to get you there.

Connect with us at Lamont Wealth Strategies to schedule a Virtual Coffee Chat and start your journey toward financial independence and becoming a Wealthy Lawyer today!