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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.
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.