How to Become Financially Independent & Get Off Your Parents’ Payroll
Learning how to become financially independent can pay off tremendously in the long run.
Contributing Writer at Tally
September 2, 2021
A recent study by the Pew Research Center found that just 24% of adults are financially independent by 22. This is down from 32% in 1980. If you're one of the 76% of individuals who are not financially independent, you’re likely wondering what you can do to get there.
This article should prove helpful whether you’re a recent post-grad or someone trying to jump-start their independent life and get out from under their parents. We'll explain how to become financially independent by providing four things you can do to start working toward financial independence today.
Defining financial independence
The term "financial independence" is broad and can have a few different meanings. According to the aforementioned Pew Research article, the formal definition is someone who has an annual income that's 150% of the federal poverty level. The federal poverty level for a single person in 2021 is $12,880. This means that you're technically financially independent if you earn more than $19,320.
A broader definition of financial independence is someone who has either "financial freedom" or "financial security." This means that they do not have any constraints on their personal finances. They have enough money to live comfortably and not worry about day-to-day expenses.
A third definition — and the group you likely hope to belong to — are those on their own financially. This means they do not rely on a parent, guardian or friend to pay off debt or assist with monthly expenses. Under this definition, financial independence means being on your own with money.
Why financial independence is important
If your current financial situation does not require you to be independent, you may be wondering why it’s important. There could be a good reason why you're not financially independent. Perhaps you're focusing on student loan debt repayment. Maybe rent is high in your area, and you can't afford living expenses.
Whatever your reason is, you should change your mindset and consider financial independence one of your long-term goals. Here are some of the downsides to not having financial independence.
It’s tougher to develop credit
Your lack of financial independence could be harming your credit. Specifically, your credit score demonstrates to lenders how responsible you are with borrowed money. The higher your credit score, the more lenders are likely to incentivize you to borrow with them, either by giving you a prime interest rate or maximizing the amount you can borrow.
If you're not financially independent, then you may have little to no credit score. While it's still possible to work with lenders without credit, it becomes much more difficult to do things like:
Take out a personal loan
Finance an auto purchase
Secure a mortgage
Becoming financially independent and managing your money responsibly now can pay dividends in your future when you're looking to make a larger purchase with borrowed funds.
You miss out on potential tax benefits
Financial independence can be beneficial when filing your taxes. If you’re not financially independent, your parents or guardians can claim you as a dependent when filing their taxes. They can do so until you're 19 unless you go to college. If that’s the case, they can claim you as a dependent until you’re 24. Claiming you as a dependent provides them with tax credits.
However, if you're financially independent, you are entitled to potential tax breaks and credits. Working with an accountant or someone well-versed in tax law could help maximize the refund you receive.
It may impact your parent’s retirement
If you’re financially dependent on a parent or guardian, you may be derailing their retirement plans. Your parents may have sat with a financial planner to figure out when they need to stop working. Supporting you may not have been a part of their retirement plan.
Similarly, becoming financially independent allows you to start building your retirement accounts. Remember, financial independence means that you're not relying on others for assistance with your monthly payments. Once you can cover your monthly bills and expenses, you can start considering other financial goals, like retirement.
How to become financially independent — 4 tips
Now that we understand why becoming financially independent is important, let's look at some of the things you can do to get there.
1. Creating a budget
Budgeting can help with long-term financial planning. With a budget, you compare your expenses to your income and set up a plan to help control your spending.
Start by figuring out your net pay each month, which is the amount deposited into your bank account after tax and withholding. You can figure this out by looking at your bank account or pay stubs from your place of employment.
From there, figure out how much you're spending per month. You can use credit card statements or bank statements to figure out the money you have going out. Try to categorize your expenses. For instance, you may break it down into the following categories:
Housing (such as a rent payment)
Student loan payment
Optional spending or entertainment
The goal in setting up your budget is to make sure that the amount of money you earn covers your expenses. If it doesn’t, you generally have three options:
Spend less in the "optional" category
Earn more money (more on that below)
Borrow from others (which goes against the goal of becoming financially independent)
Once you have a budget, consider using a debit card or cash to pay for expenses. This prevents you from overspending and taking on credit card debt. It also increases the likelihood that you stick to your budget.
Keep in mind that when you're setting a budget for financial independence, consider expenses you'll be taking on once you're living on your own. For example, if you don't have a rent payment now, you'll need to factor that into your future budget to ensure that you can move out and live independently.
2. Finding a stable income
As mentioned above, if your expenses are more than your income, you need to find a way to turn this around so that you're cash positive.
Start by focusing on finding a stable income. Look for jobs with guaranteed hours or something that is salaried. This makes it easier to predict your future earnings, though you should remember that nothing is guaranteed.
Another way to help boost your income is by picking up a side hustle to provide secondary income. Working a side gig or earning passive income could be worth the effort as it allows you to become more comfortable financially.
3. Pay off debt and avoiding new debt
If you're in debt, you may have felt as if you’re "drowning" or that it's inescapable. Perhaps the debt is forcing you to lean on others for financial assistance. This can especially be the case with credit cards, which typically have the highest interest rates. They also have compound interest, which means you're charged interest on top of interest.
As mentioned, the first thing you should do is stop taking on new debt by using debit cards or cash for purchases and avoiding additional charges on your credit cards. You can then build your debt payments into your monthly budget.
4. Start saving money
Once you're out of debt, you can start saving money. You should start by building a rainy day or emergency fund. Generally speaking, this account should cover six months of living expenses and be a dedicated savings account that you don't touch unless an emergency happens.
After you've built your nest egg, you can put extra savings into investment accounts and IRAs. A financial advisor can help you get into the stock market and determine which investments best meet your current and future needs.
Start working toward your financial independence today
More Americans than ever before are financially dependent on someone else. While this situation may often seem unavoidable, you can learn how to become financially independent.
Financial independence has its perks. It can help you build credit, which benefits you in the long run. It also means you're more comfortable financially and are likely able to save money for retirement.
Fortunately, some tools and tips can help you reach financial independence. Start by creating a budget, controlling your spending and increasing your income. Also, consider using Tally to help pay off credit card debt so that you can start saving money and working toward your financial independence.