This week, CNBC published a story about how a family making $400,000 isn't wealthy and could barely make it by in a high cost of living state.
I'm not going to nitpick the budget itself (with one exception) other than to say that it contains a few mistakes.
What I will do is explain why it's wrong by explaining how someone could not only survive but thrive, when you earn more than six times the median household income.
Challenge Your Assumptions
Before we get into specifics, there's something about this budget that irks me. It's not the numbers, it's what the numbers represent.
Two ideas push this imaginary family so close to the “edge.”
First, there's this idea of the hedonic treadmill. It's the theory that when you get nice things, the good feelings you get from it quickly dissipate. To get them back, you need to spend more. This is why someone making $90,000 a year might not feel rich. You constantly need more stuff to get that feeling – so you constantly buy more stuff.
The second idea is that happiness is, in a sense, relative. You feel successful when you're doing better than the next person. It fuels this “keeping up with the Joneses” idea. When you live in an expensive area, you see expensive things that you probably don't have. This is why that budget fixates so much on Gap vs. Gucci and Toyota Highlander vs. Land Rover. (by the way, the Toyota Highlander is still an expensive car, starts at $35,000 – it's not a budget car like a Yaris at $15,000 MSRP)
The problem with these comparisons and this is exacerbated by social media, is that you constantly see everyone's highlights. You see one family's amazing vacation and another family's expensive car and … you get the idea.
You aren't making a fair comparison – total life to total life. All or nothing. If you did, there are likely aspects of their life you don't want. Do you want an amazing vacation but have to work an 80-hour workweek? Do you want their $2 million home but you have to fly out of town during the week because you're consulting?
This leads to the next section…
You Have to Make Tradeoffs
The example budget showed that the couple was able to fully contribute $39,000 to a 401(k), contribute $18,000 to a 529 plan, as well as pay for daycare and preschool for their two kids. Oh, they live in a $2 million home with a $1.6 million mortgage ($80,952 per year in mortgage payments). And they give $3,000 to charity each year.
The reality is that you cannot do all of that at once.
You can't save $57,000 per year and claim you're struggling.
My friend Paula Pant, who runs the great blog and podcast Afford Anything, uses a phrase I really like, “You can afford anything, but you can't afford everything.”
You can have a $2 million house. You can have two kids in both daycare and preschool. You can fully fund your retirement. You can contribute $9,000 per kid per 529 plan per year. You can donate $3,000 to charity.
But you can't do all of those things and then complain about how you're barely scraping by. It's not honest.
It's like someone being at a buffet and complaining that they don't have enough stomach for all the delicious food.
Be Smarter About Your Taxes
I know that the example budget was thrown together quickly to illustrate a point – but it takes a few liberties, for the sake of simplicity, that makes it hard to accept.
This isn't a nitpick (because it's a big deal) but the example budget showed a family that was paying $80,952 each year towards their mortgage but taking the standard deduction. With how amortization works, it's unclear how much of that amount is deductible interest but I expect that it'll be more than the standard deduction of $24,400.
When you add in their other deductions, the standard deduction appears even worse of a choice.
A family of four that makes $400,000 is not paying that much in taxes. It's convenient as an example and helps the story, but their tax rate is too high.
If you itemize your deductions and take advantage of all the tax benefits of having children (child care tax credit, dependent HSA, etc.), you are probably talking closer to a 20% effective tax rate at the federal level (play with Nerdwallet's simple income tax calculator to see for yourself). Then, you add in 5-6% back for state and local taxes (remember, high cost of living state!) and you're at ~25%.
You might say “Oh, 5-6% isn't a big deal” but that difference is over $20,000 post-tax each a year – which is enormous. And that's not taking into account other deductions they may have but aren't shown in the example!
Tighten Your Budget For the Short Term
But let's say you accept the budget and that the couple is living on the financial edge (please ignore the $57,000 they are saving each year towards retirement and education) – plenty of people making far less live on that edge year after year (and they can't reduce their retirement contributions).
The challenge for those families is that when you make $60,000 a year, cutting 10% of your expenses is going to be a far smaller number than someone who is used to a budget fueled by $400,000 in income.
But fine, we will play this game because far less affluent Americans play it every day, and the reality is that this family doesn't have to live this way for many more years. They have line items that end in a few years.
When you have kids in daycare, it's like paying for a year of college. But like college, the kids aren't in daycare forever. They're in there for five to six years, after which they're done and you get this money back in your budget.
Don't Conflate High Income With Wealth
A high income can help you become wealthy but having a high income does not make you wealthy.
Wealthy is a term that means a lot of things to a lot of people but it has just one meaning for me – having a high net worth.
Being wealthy means you've escaped financial gravity.
It's hard to tell with a budget, it's more like a snapshot of what goes in and out of that family's bank account, but we know that their only investments are in retirement accounts and a 529 plan. We know this because they have no investment income, which often enjoys favorable tax treatment.
If they had a taxable brokerage account holding shares of the Vanguard 500 Index Fund (VFIAX), they'd get dividend income each year. Qualified dividend income is taxed at long-term capital gains rates, which is far lower than your income tax rates. They can spend that income or, and this is better, reinvest it so their holdings increase.
Over time, this cash flow can be extremely valuable and provide them with flexibility in their budget.
If you make a high income, you need to save more of it so it can work for you.
Cut Out Charitable Giving
Charitable giving is important, especially when you make $400,000 a year, but not if it puts your financial situation in jeopardy. We don't know what their emergency fund situation is like (we do know they have no debt) but if your annual cash flow is just $34 a year, you're on the edge.
When I talk about tradeoffs, unfortunately, it also means charitable giving too. You'd be better off taking that money, investing it, and then making a much larger donation later once you're in a better financial situation (especially if you don't even get the deduction because you're taking the standard deduction).
If you invest the money, donate the investment and you get even better tax treatment. When you donate appreciated stock, you deduct the value of the stock at the time of the donation – not your cost basis. If you buy a share of stock for $50 and it rises to $100, donate it and you get a charitable deduction of $100 even though you only paid $50.
(this is not an argument that everyone should cut out charitable giving – but if you are so close to the financial edge that only $34 is left on a $400,000 income, you should defer these donations until your cushion is larger)
To This Mythical Family, I Want To Say…
If someone is making $400,000 a year and struggling, I feel for you. I don't want to discount anyone's experiences but you voluntarily walked into this prison. Whether you were coerced by the pressures of society or by the expectations of your peers and family, you chose this.
When I was younger, I bought into a narrative as well. I was supposed to study hard, get good grades, get into and graduate a good college, and then get a job. Work that job, get promoted, make more money, start a family, etc. There's nothing wrong with that. In fact, it's a great path.
Throughout our lives, we are told these stories of what we're supposed to do. Ask any adult who isn't married – how often do they get asked about dating and when they will get married? Ask a couple with no kids – how often do they get asked about having kids?
If you're making $400,000 a year, it's clear you're a smart person who has taken advantage of the opportunities before you to succeed financially.
Just take a few moments each day to think about whether you've applied your smarts, ambition, and drive in the direction you want – or whether you're simply following the storyline others have written for you.
Joanne Saville says
First let me get this gripe out of the way. I am a vet on disability, and have tried twice to go back to school. This is important because my budget is LESS than $10,000 a year, and when my ex decides not to pay child support it’s down to LESS than $5,000 a year. To say the least it’s not easy to read articles like this knowing I can’t even HOPE to save for my daughters’ college educations, and I represent a sad amount of the population that has a hart time relating to the “I can’t make it on $400,000 a year” conversations. That being said; I think based on the audience the article is trying to reach, that audience may want to see where they can cut costs to put some money towards good counselling. They should also consider finding a home and a better support network with lower expectations so they don’t feel such a strong need to “keep up with the joneses” binge watching ‘Hot in Cleveland’ may be able to help with this (It’s a betty white comedy involving older Californians transplanting to Ohio when they realize they aren’t looked down on for their age or status among other things). Something else to consider is planning for a cheaper retirement, and a lower cost school which would mean a lower save rate for those expenses. As far as donations you can still donate time to places, and donate items, but these depend on your motivations for donating. If it’s for deductions you can give to goodwill or habitat for humanity and get write-offs. I’m not in a position to have write-offs, but I donate my girls’ cloths when they grow out of them, and other items that I need to let go of. If your donations are for more personal reasons you can donate your time to places helping others, you can start a go-fund me or other charitable account, or use social media to draw attention to a cause you are wanting to aid. Just my two bits.
Bill says
It’s a humorous analysis and probably more relevant than we care to admit for some, but I like your comment that they’ve created their own prison. I’m sure many would love to have that type of income and deal with that kind of problem. Lots of opportunity to make adjustments. It all boils down to living within your means. Something we as a society struggle to do. From our government on down. Thanks for the article.
I think there’s something anyone can learn from this article regardless of their income – it’s just made maddeningly obvious when the amount of income is $400,000. There are folks making $100,000 who fall into the same traps.
Michele Adams says
Jim, I love this!!! Even though I don’t make 400K per year (and probably never will), this is some really good advice for everyone. Thanks!
Francis Tam says
Hi Jim, just read this article. It’s great that this couple makes 400k per year. It provides a lot of financial cushion. But you are right. No matter whether you make 400k or 40k, you need to accept the financial consequences that come with the choices you make. You can never really afford everything in life, there’s always give and take. For example, instead of sending kids to daycare, they can choose to have parents watch the kids instead, give a little less to charity or defer on a dream vacation.
Exactly – but kudos to this imaginary family for sacrificing vacations for retirement and schooling!
Le says
Hi Mr. Wang
I want to start by mentioning your email promoting Biden’s tax plan. This is really just another political ploy for votes because most people who make $400,000 or more have the ability to play the tax loopholes and lessen their tax burden. In reality there is no change in collected taxes and many times the law is written to even add loopholes to allow this “family” to save even more.
Second, I think part of what you are missing is when someone is complaining about “struggling” at $400,000. Yes they have nice things and yes they are able to save money, but they earned it they have every right to spend that how they would like. They also do not have services available to them that others do. A college education is expensive even smaller colleges and yet they know that their children will not be eligible for the same government assistance and even many of the scholarships available to those with lower incomes. So yes they save. What happens if they get sick and can’t work, there is no government assistance available until you are basically destitute, so they save. Most of them work many long hours forgoing vacations and days of relaxing and look forward to a day when they can retire and do those things, so they save.
For instance, President Obama, when he was in office he earned his pay and used it to the benefit of his family. President Trump, is now in office and his earnings go to various charities every month. In both cases they have the right to do as they wish with there money.
Also, nobody WANTS to pay more taxes in all honesty. I in no way make $400,000 a year but even with the money I do pay in taxes I wish I had more say in where my tax dollar is spent. I really believe our government has grown so much that it is eating itself and some of the reasons we have such strange laws being passed in congress is simply to feed the monster. It really has gotten out of hand, but that is another subject.
As I said, I do not make $400,000 a year but I work with a few who do and most of them dislike having more and more of THEIR earnings just TAKEN from them. These are people who give a lot to charities and organizations, but in doing that THEY get to support causes THEY believe in. They would like to continue to do that but if they have to pay larger taxes guess what someone loses.
I don’t think when you hear people complaining about money issues when they make $400,000 a year they are asking for a pity party. They just are tired of working hard and then seeing more and more money stripped from them for a huge government bureaucracy to do with as they please.
I’d like to clarify that my email “promoting Biden’s tax plan” didn’t promote anything – I merely said that the reason for the $400,000 figure (vs. $500,000 or $200,000) is because that’s the line drawn by Biden’s plan. I’m not promoting anything.
There also seems to be this pervasive belief that people with moons are able to instantly take advantage of loopholes not available to other people. It doesn’t work like that, the loopholes aren’t “instant,” but usually created years ago (such as a trust) and used over time.
I had difficulty following the second part of your comment and it felt like it was conflating a series of points, just to end with “no one wants to pay more in taxes” and “they can spend their money better than the government.”
It’s a mix of political rhetoric and familiar tropes.
Mable says
Yes, Trump donates his taxes, or doesn’t take more than a $1 salary—which it is depends on what you read. However, his never ending golf trips cost taxpayers a hell of a lot more than his salary would, so perhaps he should keep his salary and use it to pay for his golf trips! It would be better for the economy.
Le says
and perhaps “promote” was the wrong word but the paper tiger worked I suppose because then you would not need to address the fact that you said:
“I know the subject sounds ridiculous. That’s because it IS ridiculous.
Every few months, there’s a story about how someone making half a million
dollars a year could be “just scraping by.” This time, it’s $400,000 because Joe
Biden said that only those making over that amount would see a small tax
increase under his administration (the top 0.5%-1% would see most of the
increases).”
That doesn’t sound like promoting at all…he just SO HAPPENS to be running for President
There are many more ways other than trusts that the wealthy absolutely DO have access to getting around paying taxes. Perhaps starting a Foundation or holding property internationally. I have seen these and many others over time.
And difficulty understanding the second part of comment was not political trope at all. Most Americans would really like there to be less government allowing us to keep our money and have more control over what our money supports. Simple enough?
I guess sometimes it is hard to understand someone who may not think the way you do but if you try I’m sure you can understand. Disagreement is not a dirty word. Just remember always two sides and the greater person is the one who is open to seeing both.
It is hard to understand your arguments when you couch them in insults and nebulous statements that sound plausible. Thank you for taking the time to share them.
Cory says
Great article Jim. These mythical people could certainly benefit from a tax planner and financial advisor. I found it made some great points and illustrates how, regardless of how much money you make, it never feels like enough. Anytime I broach the subject of high earners online, it’s met with an incredible amount of disdain and criticism much like many of these comments.
It can be a challenge to talk about high income because so few people earn that much – which makes it even harder to know what to do. The unfair part is that being a high earner shouldn’t have this stigma. It’s not like someone who inherited wealth – I can understand the disdain for someone who hasn’t “earned it.” But being a high earner literally means you earned it.
Drbob says
I’m not rich but I use the same tax break as Trump: you get to depreciate your rental homes against your income even though their value is increasing. You pay very little federal tax, but pay lots of others, like property, sales, etc.
Of course, when you finally sell, you “recapture” the earnings as a big capital gain, and the government gets its slice at 20 percent.
So Trump or estate will ultimately pay out a thousand times more than the average person, but of course the average person is too uninformed to know that, which is why I wouldn’t release my taxes either! The average voter just isn’t going to take the time to understand and the media isn’t going to help them to.
There are, of course, tax loopholes out there, most famously “carried interest “ for the hedge fund guys; the Republicans don’t mention it and Obama promised to end it but didn’t even try when he had both houses of Congress.
Same reason: big donations from billionaire hedge fund guys, to both parties, of course.
Cindy Brick says
While I found both yours and the original posts interesting, I kept thinking:
*How many people actually have this kind of income? How many make closer to $40,000, instead? You seem to be saying that we should feel concerned that these poor imaginary people end up with $34 extra yearly — when I can follow right down the list and see ways they could cut their expenses all down the line, without much pain.
*So instead of learning to cut back, they should cut out all giving to charity?? (Yes, I understand you’re making this secondary concern, behind vacations.) And what will people who are truly needy rely on, when those charities don’t have enough to help out?
*Yes, they have the right to spend their money however they see fit. But there is also a mandate to do it wisely: “With great authority, there is also great responsibility.” I would argue that applies to income, as well. Our world is too messed up to just throw money around like a drunken sailor, when a little extra $$ might help. I am constantly amazed at celebrities donating what seems like big bucks, when it’s merely a scraping off what they earned FOR THE YEAR. If we all donated 10% of our income to charity, particularly to a responsible charity that used its donations well, amazing things could happen.
What might be interesting — do another two articles: how to live on $100,000 a year, and how to live on $40,000 — or less. They would be a good contrast this this post.
You make excellents points and I like the article suggestions – I agree that there are better things to cut out before charity!
Margaret Doran says
Just a note based on information available from the Social Security Administration. In 2019, the latest year for which complete statistics are available, the median household income, as reported to and compiled by the SSA, was $34, 248.35. That’s total *household* income. The average wage earner for that year was $51,916.27. That’s per *individual.* These are not “adjusted gross” amounts that Biden has referred to in his tax plan, but actual gross income. These are telling figures, and no encouraging either for the 50% who fall under that magic median number, nor for the average earners although at that rate, two average earners would drag in almost $102K a year. So who is the middle income group, the group that supports the country with their taxes? It seems to have disappeared or, using those “average income” numbers, it’s been reduced to such a small number it seems impossible for them to support the country. Fully half of our population effectively lives in poverty. We, too make sometimes difficult choices: heat or food; housing or food. Food banks are helpful, but they assume a kitchen and cooking facilities. I am cynical and I do not believe that raising taxes on those who are truly wealthy will solve the issue . . . there are always high-priced accountants and tax preparers who will happily find loopholes and cook the books over the heat of earnings, holdings, deductions, incorporating, transferring real estate, and more. Not just cynicism, however, as a bookkeeper for years, I’ve watched it happen.