Reaching financial independence is the holy grail of personal finance. But what does financial independence really mean? In this post Id like to determine the three levels of financial independence. Thats right. Even in financial independence there is no one size fits all since everybody has a different desired standard of living.

Contrary to what you may think, financial independence is not all about having enough money to cover all your expenses. Financial independence also means being able to overcome your psychological fears to truly live free.

For example, I have peers who have millions in net worth. Yet, they still make their respective spouses work because they do not feel 100% financially secure. WiFi!Common reasons include the need for health care coverage or their spouses love for their job even though theyd rather be doing something else.

Here are the three levels of financial independence Ive come up with. All three levels of financial independence should meet the following basic criteria:

1) No need to work for a living. Investment income or non-work income covers all living expenses into perpetuity.

or

2) Net worth is equal to or greater than the number of years left in your life X living expenses. For example, $3 million with 30 years left to live is FI if your living expenses are no more than $100,000 a year.

If your household income is less than ~$40,000 a year, you are considered lower middle class. Dont be offended. Its just a definition based on millions of datapoints. The current official poverty threshold is an income of $25,000 per year fora family of four and $19,000 for a family of three.

If you are happy with living a lower middle class lifestyle, then you would need between $800,000 $1,600,000 in investable assets returning 2.5% 5% a year to replicate the $40,000 in gross annual income. Of course if youve been investing in the bull market for the past 10 years, youve likely seen a higher return than 5%. But over the long run, its best to stay conservative since downturns do happen.

Given the 10-year bond yield is at under 1%, everybody should make at least 1% a year on their investable assets risk free. If youre losing money during your financial independence years, you havent been investing properly.

This category of financial independence is interesting because theres a lot of tradeoffs the individual or couple still make, such as:

The question many people have in this stage is therefore: Are you really FI if youve got to do one or many of these things? Many who work a day job argue no, but it doesnt matter because nobody can tell you how to live your FI life. If you dont have to work a full time job and can cover your expenses, you are Budget FI as far as Im concerned.

Budget Financial Independence is where I found myself between 2012 2014. I was earning about $80,000 in passive income, which was more like $40,000 since I lived in San Francisco, and had negotiated a large enough severance to last for 5-6 years of living expenses.

Even with these numbers, I was still afraid that I had made the wrong choice leaving a job at 34. As a result, I tried to sell my house and downsize by 70%, but nobody wanted to buy my house in 2012 thank goodness.

Further, my wife and I agreed that she work for three years until she turned 34 (hooray for equality) to give us enough time to figure out whether we could both leave the workforce. At the end of 2014, she negotiated her severance as well before her 34th birthday.

Related: What Is Lean FIRE?

The median household income in the U.S. is roughly $64,000. $64,000 is therefore considered a comfortable middle class income If you didnt have to work for your $60,000 a year income, then life should be better, maybe even fantastic.

Based on a conservative 2.5% 5% annual return, a household would need investments of between $1,200,000 $2,400,000 to be considered financially independent. Once youve got at least $1,200,000 in investable assets and no longer want to work again, I dont recommend shooting for an overall return much greater than 5%. You can carve out 10% of your investable assets to go swing for the fences if you wish, but not more. There is no need since you have already won the game.

Remember, once youve reached financial independence, you no longer have to save. Everybody striving for financial independence tends to save anywhere from 20% 80% of their after tax income each year on top of maxing out their pre-tax retirement accounts.

Therefore, if youre able to 100% replicate your gross annual household income through your investments, youre actually getting a raise based on the amount you were saving each year.

If you have 20 years left to live and only require $60,000 a year, having $1,200,000 can also be considered enough even if you make zero return. The only problem is that your purchasing power will decline by ~2% a year due to inflation. The other problem is that you dont know exactly how many years you have left to live. Therefore, its always better to have more rather than less.

My blogging buddy Joe from Retire by 40, who is six years older than me, is a good example. He has enough money, but is still finding it difficult to overcome the fear of not working.

Every year, he questions whether his wife can join him in retirement. This is even though he has close to a $3 million net worth. He also has online income and passive income. Every year I tell him she could have retired years ago, but hes adeptly convinced her to keep on working.

Related:Achieving A Two Spouse Financial Independence Lifestyle

This is a level of FI that Ive been trying to achieve since I was 30 years old. I decided back then that an individual income of ~$200,000 $250,000 and a household income of ~$300,000 was the ideal income for maximum happiness.

With such income, you can live a comfortable life raising a family of up to four anywhere in the world. Given Ive spent my post college life living in Manhattan and San Francisco, it was only natural to arrive at much higher income levels than the US household median. Remember, half the country live in more expensive coastal cities.

These figures are partially due to a highly progressive tax code that was implemented in the mid 2000s. The government really went after income levels above these thresholds. Further, I carefully observed my happiness level from making much less to making much more. Any dollar earned above $250,000 $300,000 didnt make a lick of difference. In fact, I often noticed a decline in happiness due to the increased stress from work.

Using the same 2.5% 5% return figures, one would therefore need $5,000,000 $10,000,000 per individual and $6,000,000 $12,000,000 per couple in investable assets to reach Blockbuster Financial Independence. In addition, it is preferable if your home is also paid off.

If you are generating $250,000 $300,000 in passive income without having to work, life is good, really good. In 1H2017, I got to about ~$220,000 in annualized passive income. But then ended up slashing ~$60,000 from the top after selling my rental house to simplify life. Therefore, Ive still got a long ways to go, especially now that I have a son to raise.

Today, my passive income is around $260,000 +/0 $25,000. Its a comfortable amount of money, but it may not be enough given I now have two kids. Therefore, my goal is to shoot for another $40,000 in passive income by 2023. 2023 is when my boy will be eligible for kindergarten.

The way many people reach Blockbuster Financial Independence with income of $250,000 $300,000 is through a combination of investment income and passion project cash flow. Since FI allows you to do whatever you want, heres your chance to follow the clich, follow your passions and the money will follow without worry that there will be no money. My passion so happens to be this site. Everybody should start their own today.

Related: What Is Fat FIRE? The Best Way To Live Life In Retirement

Even if you find yourself in the Budget FI category, its still better than having to work at a soulless day job. Just getting rid of a long commute or a terrible boss makes Budget FI worth it.

Most people who find themselves in Budget FI are either on the younger side (<40), dont have kids, or are forced to live frugally. Ive found that in many cases, folks in Budget FI long to lead a more comfortable life so they either get back to work, do some consulting, or try to build a business within three years to move up the pyramid.

The only way Ive found to successfully overcome the fear of not working is by either negotiating a severance, building enough passive income to cover all your living expenses for at least 12 consecutive months, or trying out FI living first while your partner still works. Feeling comfortably FI doesnt just happen with a snap of the fingers.

There is this natural urge to still make financial progress by continuing the good financial habits that got you there in the first place. And wonderfully, the progress you make is like finding loose diamonds after youve already found a pot of gold.

Related:Ranking The Best Passive Income Streams

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The Three Levels Of Financial Independence: From Budget To ...