25% Rule, Explained: What Counts… and What Doesn’t

Key Concepts

• Financial Order of Operations: A structured approach to managing personal finances, moving through distinct steps to achieve financial independence and abundance.
• FIRE Movement (Financial Independence, Retire Early): A lifestyle focused on aggressive saving and investing to achieve financial independence and retire earlier than traditional retirement age.
• Tax-Advantaged Accounts: Investment accounts that offer preferential tax treatment, such as 401(k)s, IRAs, HSAs, and 529 plans.
• Taxable Brokerage Account: A standard investment account with no contribution limits and potential for lower capital gains and dividend tax rates, especially at lower income levels.
• Abundance Goals: The stage in financial planning where individuals can focus on increasing their lifestyle, pursuing passions, and making significant purchases or investments.
• Wealth Multiplier: The concept that the earlier one starts investing, the greater the potential for their money to grow and compound over time.
• Generosity: The act of giving to charitable causes, which can also have tax benefits.
• Professional Financial Guidance: Seeking assistance from financial advisors to navigate complex financial decisions and ensure optimal strategies.

Step Seven: Utilizing Your Savings for Financial Independence

This step focuses on the strategic allocation and utilization of saved funds, moving beyond simply accumulating wealth to actively planning how that wealth will be used to achieve personal financial goals. It emphasizes that the structure of personal finances should align with individual aspirations, whether that's early retirement (FIRE movement) or other endeavors.

• Key Point: Step seven is where the "how" of using money is addressed, distinguishing it from earlier steps focused on avoiding financial pitfalls or tax optimization.
• Account Structure: The need for diverse account structures beyond traditional 401(k)s is highlighted, especially for those in the FIRE movement who may require earlier access to funds.
• Discipline Over Income: The transcript notes that individuals with high discipline can reach step seven even without maxing out 401(k) limits, as the focus shifts to strategic retirement planning with all available benefits.
• The 25% Savings Rate:
  • What Counts: Contributions to employer-sponsored plans (401(k)s, 457s, 403(b)s), IRAs, HSAs (if invested), pensions (for educators), employer matches (for eligible income levels), ESOPs, employee stock purchase plans, and after-tax savings for future financial independence.
  • What Does Not Count: Prepaying mortgage principal, real estate investments (rental properties), and principal payments on a mortgage are explicitly excluded from the 25% savings rate calculation for liquid portfolio growth.
• Taxable Brokerage Account Benefits:
  • Flexibility: Offers maximum flexibility for using funds, including for retirement.
  • No Contribution Limits: Allows for unlimited contributions.
  • Tax Advantages: Benefits from lower capital gains and dividend tax rates compared to ordinary marginal tax rates, potentially even 0% capital gains for those with low income.
  • Early Access: No penalties for early withdrawal, making it ideal for FIRE movement participants who need access before traditional retirement ages (59.5).
• 0% Capital Gains Opportunity (2025):
  • Single Individuals: Adjusted Gross Income (AGI) below $48,350.
  • Married Filing Jointly: Household income below $96,700.
  • Implication: Allows for tax-free growth and sale of investments if income remains below these thresholds during retirement.

Step Eight: Prepaying Future Expenses and Abundance Goals

This step shifts focus to preparing for future needs and enhancing one's lifestyle, emphasizing that these actions should only be considered after establishing a solid savings foundation.

• Prepaying Future Expenses (Children's Needs):
  • Timing: Recommended after step seven is secured.
  • Examples: College savings (using 529 plans with state tax incentives), helping children open custodial Roth IRAs (with parent match), saving for a child's first car, down payment for a house, or a wedding (using UGMA/UTMA accounts).
  • Rationale: Prioritizing personal financial security before funding children's expenses.
• Abundance Goals (Lifestyle Enhancement):
  • Definition: This stage allows for increasing one's lifestyle, planning for vacations, making large purchases, or investing in new ventures.
  • Real Estate Investment: Aspiring real estate investors can consider residential or commercial property.
  • "Bad Decisions" Management: For expensive purchases like European cars, the advice is to rent or lease rather than own to avoid high maintenance, fuel, and repair costs. This is permissible in step eight because the individual's future financial security has already been established.
  • Age as a Factor: The transcript suggests that making lifestyle choices like purchasing expensive cars is more appropriate for individuals in their 50s, who have likely secured their financial future, rather than those in their 30s who may not have adequately funded their retirement.
• Financial Order of Operations and Lifestyle: The framework is designed to prevent individuals from being "tight wads" when it's detrimental to relationships and goals, allowing for a balanced approach to spending and saving.
• Defining Abundance: Abundance is personal and can vary from person to person. The financial order of operations liberates individuals to use money as a tool to achieve their unique definition of abundance.
• Debt Payoff (Low-Interest): While not the most optimized strategy, paying off low-interest debt, such as a mortgage, is acceptable in step eight if it aligns with personal goals and doesn't compromise future financial security.

Step Nine: Wealth Multiplication and Age Considerations

This step emphasizes the significant impact of age on wealth-building potential and the strategic decision-making around debt payoff.

• Age and Wealth Multiplier:
  • 30-Year-Old: Wealth multiplier of 23 times.
  • 50-Year-Old: Wealth multiplier of 3 times.
  • Implication: Younger individuals have a significantly greater opportunity for their money to compound and grow over time.
• Mortgage Payoff Example:
  • Scenario: A low mortgage rate (2.5%) with a balance below $100,000.
  • Opportunity Cost: The annual opportunity cost of not investing the money was less than $1,000.
  • Decision: The speaker chose to pay off the mortgage in 2025, viewing it as a way to derisk their life without sacrificing future financial security, especially as they were over 45 and had sufficient assets.
• Respecting the Financial Order of Operations: The decision to pay off the mortgage was made after ensuring that step eight (abundance goals) was met and that it wouldn't be a sacrifice to their future self.

Step Ten: Generosity and End-of-Year Financial Assessment

This final step focuses on giving back and conducting a comprehensive review of one's financial situation before the year concludes.

• Generosity:
  • Timing: A great time to consider supporting causes and donating money.
  • Efficient Giving:
    • Charitable Giving Fund: Consider opening one.
    • Highly Appreciated Securities: Donate these for potential tax benefits.
    • Bunching Charitable Giving: Consolidate donations to maximize tax deductions, especially if aiming to reach the standard deduction threshold.
  • Personal Impact: Donating items (e.g., unused clothing) can also provide a financial benefit by lowering income taxes.
• End-of-Year Financial Assessment:
  • When to Seek Professional Help:
    • When the gravity of financial decisions becomes overwhelming.
    • When life circumstances become complicated.
    • When there's a lack of knowledge about tax strategies or a fear of missing out.
    • When busy schedules lead to financial tasks being neglected.
  • Fulfilling the Abundance Cycle: Engaging a professional can help navigate complex financial situations and ensure that financial goals are met.
  • Personal Finance is Personal: The transcript emphasizes that financial journeys evolve, and what starts simple can become complex with success.
  • Professional Partnership: The content creators offer to be a "co-pilot" for individuals managing significant financial enterprises, suggesting that professional guidance can provide a "better way to money."