Why households need to earn $300,000 a year to live a middle-class lifestyle

Sam Dogen, Financial Samurai
Yahoo Finance
The downtown skyline stands past Victorian homes in San Francisco, California, U.S. Photographer: David Paul Morris/Bloomberg via Getty Images
The downtown skyline stands past Victorian homes in San Francisco, California, U.S. Photographer: David Paul Morris/Bloomberg via Getty Images

This post first appeared on Financial Samurai.

Let me tell you a sad story. In order to comfortably raise a family in an expensive coastal city like San Francisco or New York, you’ve got to make at least $300,000 a year. You can certainly raise a family earning less as many do, but it won’t be easy if your goal is to save for retirement, save for your child’s education, own your own home instead of rent, and actually retire by a reasonable age.

Although $300,000 is a lot compared to the median household income in the United States of ~$59,000, it’s not an outrageous sum of money once you look at the realistic income statement I’ve put together for this post. All expenses in my example use current prices. I’ve also cross checked the expenses with my family’s monthly expenses now that we have a son to make sure they are within reason.

I use $300,000 in this post because I also believe it is the ideal income for up to a family of four to experience maximum happiness. At $300,000, you aren’t paying an egregious amount in taxes, you probably aren’t killing yourself at work if both parents are working, but you’re still earning enough to live a comfortable lifestyle anywhere in the world.

Half the U.S. population lives on the coasts, therefore, this post is directly targeted at folks who need to live on the coasts because of their jobs, schools, or families. Three hundred thousand dollars is a nice household income to shoot for, but not much more, if you are a coastal city resident who makes less.

Finally, this post should also provide insights to non-coastal city residents on how good you’ve got it if you enjoy living where you are. $100,000 – $150,000 is a rough non-coastal city household income equivalent.

Who makes $300,000 a year?

Before we look at the income statement, I’d like to go through a list of various workers who will eventually make ~$300,000 on their own or in household income if they find someone who also works.

* A Bay Area Rapid Transit janitor made $234,000 + $36,000 in benefits in 2016

* A Bay Area Rapid Transit elevator technician made $235,814 + $48,429 in benefits in 2016

* Starting salaries for 22-year-old employees at Facebook, Google, and Apple range from ($80,000 – $120,000) + ($10,000 – $50,000) in annual equity grants.

* A 30-year-old first year Associate in banking earns $150,000 in base salary + ($0 – $120,000) in bonus

* A 26-year-old Airbnb employee shared he got a $250,000 total compensation package back in 2015

* A 26-year-old first year law associate at a firm like Cravath makes $180,000 base + $20,000 sign on bonus. By the end of their sixth year they are making over $300,000.

* A 29-year-old director of marketing at a startup makes between $120,000 – $180,000.

* A personal finance blogger with 500,000 pageviews earns between $150,000 – $600,000

* A 42-year-old college professor at Berkeley makes $235,000 on average and $279,000 at Columbia and NYU

* The average specialist doctor finishing his or her fellowship at 32 makes $300,000. The average salary for a primary care physician is $200,000.

* A 26-year-old middle school teacher making $55,000 a year plus her $250,000 a year VP of marketing wife

* A 56-year-old high school athletic director making $100,000 a year plus his $200,000 a year management consultant husband

The permutations of people making $300,000 goes on and on. For many professionals, if they aren’t there now, they will get to such a level of income eventually if they team up.

Living a middle-class lifestyle on $300,000 a year

Please study this chart closely. Every expense has been carefully vetted by dozens of people who live in expensive metropolitan areas like NYC, LA, and SF and diligently track their cash flow to give you the most realistic budget possible.

Source: Financial Samurai
Source: Financial Samurai

Gross income review

This dual income household puts away the maximum $18,500 a year each in their respective 401(k)s. With the passage of new tax laws in 2018, they’ve lost their ability to deduct more than $10,000 worth of state income, sales, and property taxes. As a result, I’ve used the new $24,000 standard deduction for married couples to keep things simple.

For 2018, the FICA tax rate for employers is 7.65% — 6.2% for OASDI and 1.45% for HI. An employee will pay a 6.2% Social Security tax on the first $128,700 of wages (maximum tax is $7,960.80 [6.2% of $128,400]), plus. Since both parents work, both parents pay the tax. At least both parents eventually gain when they collect Social Security.

They have a marginal federal income tax rate of 24%, a marginal California income tax rate of 9%, and most of their income facing a 7.65% FICA tax since both work. Their combined effective tax rate is roughly 32%, for a tax bill of ~$76,480. Yes, their total tax bill is ~$17,000 more a year than today’s median household income, so hopefully folks who earn less can give them some slack.

What’s nice about 2018 and beyond is that this family now gets a $2,000 child tax credit. In the past, the credit began to disappear for married couples who earned more than $110,000 and for single filers with AGI above $75,000. Now, singles and married couples can earn up to $200,000 and $400,000 respectively, before their child tax credit begins to disappear.

Child tax credit income thresholds
Child tax credit income thresholds

Child tax credit income thresholds have risen

Bottom line: their $300,000 gross income gets reduced by roughly 38% after taxes and retirement contributions.

Expenses review

Childcare ($24,000): There’s no getting around this expense if both parents are working. Babysitting and childcare for $20/hour is the standard rate I’ve found in San Francisco. I know some families who only pay $10/hour because they are co-sharing the sitter with another family. Either way, childcare for a baby/toddler before they attend first grade costs between $17 – $40/hour in a big city.

If the parents decide to send their child to private school, this $24,000 annual expense will continue. It’s a shame that so many expensive coastal cities have troubled public school systems. In San Francisco, there’s a lottery system for the sake of social engineering. In other words, even if you buy a $1.5 million median home and pay $20,000 a year in property tax, you are not guaranteed to have your kid get into the public school down the street.

Of course, if you have a second kid, childcare expenses will increase, but probably not double due to synergies.

Food ($25,200): When you are a dual job household with a baby, there’s little time to cook. Further, given the family is living in a city like New York or San Francisco, food is world class, and on demand food delivery is ubiquitous. It makes little sense to spend hours cooking when you’re already tired and want to reserve your remaining energy for taking care of your baby. However, food is where this family can cut expenses if they start feeling a little tight.

Mortgage ($46,800): Although the payment is $3,900 a month for a $900,000 mortgage at 3.25%, $2,000 of it goes towards paying down principle and building net worth. Therefore, you can add $24,000 a year in forced savings to their $37,000 a year in 401(k) savings.

Their $1.5M assessed house is a standard 2,000 square-foot, three bedroom, two bathroom home on a 3,000 square-foot lot. For new homebuyers, only interest on up to a $750,000 is taxable. Here’s an example of a typical ~$1.5 million home in San Francisco that recently sold. If you think this is living large, you’re nuts.

The $10,000 SALT cap deduction for individuals and married couples really hurts homeowners in expensive real estate markets. Property tax on a $1.5 million assessed house alone is roughly $19,200. Then the couple is paying ~$18,000 in state income taxes.

Further, this couple is lucky because they bought their home several years ago for $1.2 million. Now imagine renting a house for $6,000 a month and trying to save up $300,000 for a downpayment on a median priced home. Difficult to do with less than a $300,000 household income. Probably impossible without living in a one bedroom for “only” $3,200 a month or getting help from their parents.

After getting some real mortgage quotes online, mortgage interest rates are now reaching five-year highs while property prices are also at five-year highs. The new home buyer is therefore getting squeezed.

Latest mortgage rates
Latest mortgage rates

Mortgage rates are on the rise again

Vacation ($7,800): Some will say that spending three weeks of vacation is a luxury, but I say spending three weeks of vacation is normal for two working parents who want to keep their sanity. When I left my job in banking at age 34, I had been taking six weeks of vacation each year for three consecutive years and I took every day I was allowed off. Three weeks had felt too little for me. By law, every country in the EU has at least four weeks of paid vacation days. Meanwhile, Brazil gets 41 paid vacations days a year. Yes, their respective economies might be a mess compared to ours, but at least they are enjoying life!

Car Payment ($7,400): When you have a baby, all you want to do is protect him or her from harm. Even if you are the best driver in the world, one reckless drunk driver might t-bone you one evening. No longer do you feel comfortable driving a compact city car while transporting your family. Instead, you want a larger vehicle that has the highest safety rating.

Baby/Toddler Things ($6,000): You can spend as little or as much as you want on your baby. But this family buys disposable diapers, not washable diapers, tons of baby proofing material, lots of toys, the best car seat, and two strollers. It’s funny, but one of the best toys for our son is a tissue box.

Entertainment ($7,200): Date night can easily cost $200+ an outing for two once you include tickets to a ball game or a show and transportation. Entertainment also includes the cost of sporting equipment, memberships, Netflix, cable, internet, and more. If your friends invite you to a weekend getaway, a bachelor or bachelorette party, or a function or two, your entertainment budget will be blown to smithereens.

CPI increase
CPI increase

CPI for all urban consumers has increased by 68% since I graduated from HS in 1995

What’s Missing? Lots! Readers have pointed out student loans, gifts (not charity), and mobile phone usage. There’s a good chance that if you’re making six figures a year you went to college and graduated with debt. I went to business school part-time and borrowed $40,000 that cost between $500 – $700 a month to service for 10 years, depending on the interest rate. In fact, the average amount of debt for graduate students is $57,600 according to the the Federal Education Budget Project at New America.

Final cash flow review

The end result is annual cash flow of only ~$5,000, which could get spent in a hurry as things always pop up. But overall, this middle class family is building roughly $53,000 in net worth each year through principle pay down and 401(k) savings plus any appreciation in their investments and primary residence. Sadly, they are still paying more in taxes each year than they are in accumulating net worth!

After 22 years of work with no change in income or expenses, this household will likely amass a net worth of over $2,000,000 and the ability for at least one spouse to retire since their son will have graduated college. However, based on my recommended net worth goal for financial freedom equal to 20X annual expenses, this couple needs to accumulate closer to $3,500,000 to really feel comfortable for both to retire.

New Federal Income Tax Rates 2018
New Federal Income Tax Rates 2018

2018 Federal Income Tax Rates

After analyzing all the numbers above, the ideal household income to raise a family is $315,000 after deductions. At $315,000 you pay a 24% marginal income tax rate and avoid having to pay a whopping 8% more in federal income tax on each dollar over $315,000. This jump is large compared to the 2% jump from 22% to 24%.

Based on my experience, happiness did not increase for me when I began making over $200,000 as an individual. Happiness did not increase for us when we began making over $300,000 either. Therefore, due to the increase taxes and increase stress, it seems pointless to put yourself through the ringer simply to try and make more from a day job.

However, if this couple were to earn $376,000 and then take the $24,000 standard deduction and contribute $37,000 in their respective 401(k)s to bring taxable income down to $315,000, they would have an additional ~$43,000 in cash flow each year. For financial security and retiring earlier, that’s a nice extra buffer.

Save aggressively then move

In order for this household to achieve financial independence, they’ve got to either up their 17% gross savings rate, figure out a way to reduce expenses, or boost income. Since boosting income probably hurts their quality of life due to more work and stress, the best way is to reduce expenses and diligently keep track of their finances online in order to continuously optimize their net worth. After 10 years of aggressive saving and earning, moving to a lower cost area to work or retire could be the perfect final move.

There’s a moving truck shortage in places like San Francisco because so many people are moving out of this expensive city. The trend is towards relocating towards the heartland, where valuations are cheaper and net rental yields are much higher. If you live in an expensive metropolitan area, consider relocating to lower your cost of living or at least try and take advantage of the valuation differential by investing in Middle America. Thanks to technology, there’s no need to grind so hard in cities where the median home price is over $1 million. The country is large. Go explore it!

Sam Dogen is the founder of FinancialSamurai.com, a leading personal finance site established in 2009 that teaches people how to achieve financial freedom sooner, rather than later.

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