Deca-millionaire Democratic President, Joe Biden, has stated he will raise taxes on people making over $400K a year. Biden has called anybody who makes more than $400K “rich” and should, therefore, pay “their fair share” in taxes.
Further, Biden has stated once you make more than $400K a year, you will face a top marginal income tax bracket of 39.6%, up from 37% currently. In addition, you may likely have to pay FICA tax on income above $400K despite a cap on benefits.
Under billionaire Donald Trump’s tax plan, only after an individual makes over $518,401 does he or she pay the top marginal income tax rate of 37%. For married couples filing jointly, their income would have to breach $622,051 before facing a 37% marginal income tax rate.
$400K For Individuals Or Couples
It is STILL not clear whether Biden is making the $400K income threshold for the top marginal income tax rate for individuals or married couples.
If the $400K pertains to married couples only (most likely), then the income threshold for individuals facing the top marginal income tax rate will likely decline to somewhere around $250,000 – $300,000.
If the $400K pertains to individuals and married couples, then high-earning individuals best not get married! It would be much more tax-efficient to earn up to $400K per individual and just live happily ever after with another $400K-earning individual.
Now that the Democrats control both chambers of the house, federal income taxes are undoubtedly going up for the highest income earners. Expect to see corporate income taxes also go up and the estate tax threshold (death tax) also come down from $11.7 million per person as well.
Is $400K Really Considered Rich?
Nobody will doubt that earning $400,000 a year is a lot of money. A $400,000 a year household income puts you in America’s top 1.8% income-earners according to the IRS. Therefore, by most metrics, you are considered rich. Sadly, earning $400K a year would have put you in the top 1% of income earners just 10 years ago. Today, you need to earn over $500K a year nationally to be considered a top 1% income earner today.
However, determining whether $400,000 a year is rich or just well off depends on where you live, your family size, and the type of lifestyle you desire.
There is no guarantee you will be wealthy due to a high income. We all know plenty of people who earn a lot, but equally spend a lot. As a result, they have nothing to show for at the end of each month.
I believe a middle-class lifestyle is all any of us can reasonably expect. Therefore, here is what I consider to be middle class and rich lifestyles. Of course, our definitions may differ.
A middle-class lifestyle can be defined as:
- Owning a 3 or 4-bedroom home
- Being able to afford to raise up to two kids
- Allowing one spouse to be a stay at home parent
- Saving enough to pay for their state college tuition
- Regularly saving for retirement in a 401k or IRA
- Going on 2-4 weeks of domestic vacation a year
- Driving a median-priced car (~$30,000)
- Nosebleed seats at a concert or sporting event
- A canoe for two to row on a lake
- Retiring in one’s 60s and living comfortably ever-after
A rich lifestyle can be defined as:
- Owning a 5-bedroom or larger primary residence and at least one other vacation property
- Being able to comfortably afford to raise three or more kids
- Going on more than four weeks of vacation a year, including two weeks of international travel
- Driving a luxury car or two ($60,000+ each vehicle)
- A NetJets account for occasional private jet domestic travel at $10K/hour
- Front row seats to NBA basketball games
- A 100-ft yacht to sail the high seas with mysterious people
- Having the option of retiring before 60 if desired
- Having a lot more control of your time than the average person
Now that we’ve roughly defined the difference between middle-class and rich, let’s go through the household budget of a family earning $400,000 a year in an expensive city.
Remember, $400,000 is the income threshold where taxes will go up. A $400,000 income should, therefore, be considered the lowest income level to be considered rich according to Joe Biden.
How A Family Of Four Survives Off $400K A Year
What’s funny is that a CNBC reporter asked me to update my $300,000 household budget to $400,000 for his story. Then, in a 2-minute video clip, he only mentions a couple of soundbites. The internet then ran with it and made all sorts of interesting conjectures before I even got the chance to write this thorough post.
Instead of just talking in soundbites, let’s analyze the nitty-gritty of how a family of four survives on $400,000 in an expensive city. At the end of each month, the family is left with $3 in cash flow.
You might scoff at being left with only $3/month in cash flow. However, the family can certainly make adjustments to boost cash flow if needed. Further, I bet a good portion of American households who suddenly find themselves earning $400,000 a year would likely end up with negative cash flow.
The $400K Budget
Take a look at the $400,000 budget below that so many people in America have already scoffed at. I’ve tried to make it as realistic as possible based on my family of four’s own expenses in San Francisco (much less b/c we paid off our house) and after talking to at least 50 other $400,000+ households with two kids in a big city.
Your own expenses will obviously differ. Just don’t forget to take into consideration your location, lifestyle, and household size.
Income & Tax Analysis Of A $400K Household
Earning W2 income is the least tax-efficient way to make money. However, that’s what most $400,000 professional couples are doing. As a result, they pay a combined ~31% effective tax rate on their taxable income.
The 31% includes state income taxes and FICA tax on income up to the first $137,700. Since both parents are working, they pay FICA tax on $275,400. 7.65% FICA tax X $275,400 = $21,068. Therefore, consider the FICA tax if you’re deciding whether one partner should stay at home to raise the kids. Hopefully, Biden would only implement a new FICA tax on income over $400K.
Despite the availability of itemizable deductions, I’ve used the $24,000 standard deduction for a married couple to keep things simpler. There may be several thousand more in tax savings as a result. However, the AMT does a great job of whittling away tax benefits for high-income earners. Further, only $750K of the $1.6 million is eligible for mortgage interest tax deduction.
Although I use a $2 million home in the budget, it’s fair given the median single-family home price in San Francisco is about $1,650,000. After all, the house has four bedrooms and two bathrooms for four people.
You might still believe that $2 million means this household is living in a mega-mansion. However, I assure you that $2 million is just a regular home in a larger metropolitan area. People who can’t recognize this truth fail to compare the price to the median home price of a particular location. Everything is relative. Don’t forget this core personal finance concept.
Below is a picture of a three-bedroom, two-bathroom, 1,992 sqft, single-family home that recently sold for $455,000 over asking at $2,150,000. That’s right, this home not only has one bedroom less, but is also $150,000 more than the $2 million home in my budget.
The house is on the west side of San Francisco, which is experiencing strong intracity migration. The west side is cheaper, has more space, is less dense, has fresher air, and is closer to the beach and Golden Gate Park. As a family, you want all these things, especially if you can work from home part of the time.
People who are smart first try to relocate within their city to save money before deciding to uproot their lives and move to a place like Austin, TX where nobody knows their name. The best geoarbitrage strategy is to first relocate within your city.
Despite the $1,600,000 mortgage, within 30 years, the mortgage should be paid off. Therefore, the household will free up $80,952 a year in cash flow when the mortgage is gone.
This forced savings by owning a home is really one of the benefits of homeownership. The return on rent is always -100%.
The Cost Of Kids
A middle-class family should be able to comfortably afford up to two kids. As you can see from the budget, kids are expensive if both parents insist on working. Full-time childcare and preschool easily cost $2,000 – $3,000/month per child.
The positive is that if both kids go to public school once they reach kindergarten, this family will enjoy a nice income boost. However, many parents with a $400K+ household income want to send their kids to private grade school. Therefore, there’s a good chance this household will continue to spend $5,500+/month for two kids on private school tuition for K-12.
Below is an updated private school tuition calendar for 2021. The cost of 17 years of private school tuition in today’s dollars is $774,924 if tuition stays at 2021 rates.
I want six-figure, W2-earning parents to think about this question: What if my kids go to Harvard and end up a nobody? Will all that tuition spent be worth it? The internet has made everything free. Yet, schools like USC keep raising tuition, despite the pandemic. Therefore, the ROI continues to decline.
If you look at the statistics, private school and public school graduates generally end up earning the same amount and doing the same things. Please consider the public school or trade school route instead of your family cannot receive grants.
Tuition Keeps Going Up
If you want to have kids, it’s probably best to seek advice from other parents. Surviving, thriving, and retiring with no kids is a walk in the park compared to if you have kids.
It’s not just the cost of raising several kids that puts an extra strain on a household’s finances, it’s the time spent raising them, especially during a pandemic. It is absolutely exhausting taking care of younger children all day and trying to work.
But I would say for the vast majority of parents, they would never give up their kids for anything. Kids provide so much joy and meaning to a parent’s life.
The family is driving a Toyota Highlander with 3rd-row seating ($38K). Sure, they could buy a new Range Rover Sport for $78,000, however, then they would violate my 1/10th rule for car buying since they don’t make at least $780,000. They don’t want to do what most Americans do and waste money on cars.
Instead of shopping at Gucci or Prada, the family buys clothes from Gap and Old Navy. They also wisely bought more unisex clothing so they can continuously pass their oldest child’s clothes down to their youngest.
In terms of entertainment, the family stays mostly at home and watches Netflix and other shows on their electronic devices. However, they do like to pay for nice camping and photography gear for their weekend outings.
Finally, they are also ordering more food delivery to reduce their chances of getting COVID at the supermarket. It’s an extra price they are willing to pay to keep their children safer.
Still Saving For Retirement On $400K
Although this household only cash flows $3 a month, the household’s annual retirement savings is $39,000 due to both parents maxing out their 401ks.
Further, they are saving $9,000 a year in each of their kid’s 529 plan. They could theoretically contribute up to $15,000 for each per kid ($30,000 total) and still stay within the annual gift tax exemption limit. However, they don’t have enough cash flow.
If they really found themselves in a pinch, they could also free up $3,000 a year by eliminating their charitable giving.
With a $260,000 annual household expense, this couple won’t be retiring anytime soon unless they can get their expenses down or income up. Even if they were to send both their children to public school, they would still have roughly $200,000 in annual household expenses.
At a 4% rate of return or 4% withdrawal rate, the household would need $5,000,000 in retirement capital. $5,000,000 is equal to 12.5X their annual earnings versus my recommended 20X multiple. Given they are only saving $39,000 a year for their retirement, even with a 6.8% compound annual return, it would take 50 more years to get to $5,000,000.
Unfortunately, interest rates have plummeted during the pandemic, meaning that it takes more capital to generate the same amount of risk-adjusted income. Therefore, it’s more prudent for households to boost their retirement savings or lower their withdrawal rate in retirement.
A more conservative safe withdrawal rate of 2% would therefore require a $10 million retirement nest egg. A 1% safe withdrawal rate would require $20 million in retirement capital. Therefore, it’s best for this household to plan on earning supplemental retirement income after their day job days are over.
Difficult Arguments To Reduce Expenses
One of the most common arguments people who don’t make $400K+ have about my $400K budget is that one parent should simply stay at home to save money.
Here’s an example from Janet:
I don’t know what each of the parents make, but let’s assume the man makes 81% of the salary of the woman (a little reality flip there….). So she’s got the better job, at a little $220K a year. His salary is $178K.
Now, he quits and stays home with the kids. Zero daycare, zero pre-school (or public or church preschool rather than private), so right there: $63K gone.
He also learns to cook and feeds the kids PBJs and egg salad and tuna fish, just like much of America, and bam: food costs down to $42 per day (based on the USDA “liberal food cost” for a family of 4.
As a stay at home dad, I think it’s wonderful Janet recommends more dads stay at home. I’d love more company as I’m mostly chatting with moms in the forums and at the playgrounds. Homeschooling is definitely a great way to avoid paying for private school tuition.
However, there’s one big hole with Janet’s argument. She’s saving $63,000 in expenses at the cost of losing $178,000 in gross income! After a 30% effective tax rate, $178,000 turns into $124,600.
Many parents have chosen to pursue money and their careers over taking care of their children full-time. Who are we to judge? Equality in the workplace right?
How About Relocating?
The other common argument is to relocate to a lower-cost area of the country to save money. Although it may be easier now due to the pandemic, unfortunately, not all jobs are able to be performed remotely.
For example, if you are a doctor, it is highly unlikely you will be able to earn the same amount of money working remotely. Doctors earn about 50% less if they do telemedicine. Further, you can’t operate on a patient online. At least not yet.
If you are a techie, you may be able to work remotely. But you may also receive a pay cut and be passed up for promotions once the coronavirus is better contained.
Once you’ve built your community, it’s hard to leave your friends behind just to save a little more money.
With the pandemic hitting the lower-cost heartland the hardest, many people are having second thoughts about relocating away from the coastal states. In fact, I’m noticing greater interest in migrating to California and New York given the coronavirus positivity rates are much lower.
Besides, with a Biden victory and a divided country, the political differences may be too large to overcome, even for white people who can easily blend in. Many people feel more comfortable residing in states that have the same political ideology as the president.
Therefore, I believe there is going to be a revival in interest of Big City Living again. For example, the coronavirus positivity rate in San Francisco and NYC is less than 0.9% versus 25%+ in many of the heartland states.
$400K Is Comfortable, Not Rich
$400,000 is a big annual household income. You can certainly survive just fine off $400,000 a year. However, based on the above expenses, a $400,000 household income only provides for an upper-middle-class lifestyle for a family of four in a big city.
The good thing is that Biden has decided the top marginal tax rate of 39.6% will start at every $1 over $400,000 after all adjustments. Therefore, depending on what the lower marginal tax rates are, a household won’t really start feeling Biden’s new top marginal tax income rate burden until people start making well over $400,000. Good thing President Biden himself only has a $400,000 salary. Otherwise, he’d have to pay more taxes as well.
I would say that once a household starts making over $500,000 in AGI, will the household start noticing the pinch of higher taxes under Biden. At about $700,000, the pinch will start to feel like a body blow if all income is W2 income.
Take a look at the income required to be in the top 1% in Connecticut, New York/New Jersey, California, and the U.S. according to 2017 data from the IRS.
Given so much about the definition of rich depends on where you live, I think the minimum household income to be considered rich is $500,000 a year. But even at $500,000 a year, some households seem to just be scraping by due to poor personal finance habits.
Therefore, for a household to be considered unequivocally rich, I say it must annually be earning $1 million or more. At $1 million or more, you should be feeling rich every day. The only caveats are how much work is required to earn $1 million. We must also calculate how long the $1 million annual income can last.
Things To Consider For Higher Income Households
Everybody knows that if a $400K-income earning household with two kids wants to reduce expenses, it can. Everything is a tradeoff that only each household can decide. Here are some things to think about:
- Be proud and grateful of your $400K+ income. You are likely paying more than $100K in taxes each year, which is 99% more than all other Americans. Don’t let people, including politicians, say you aren’t paying your fair share because you clearly are. You’re also probably killing yourself at work to make $400K+. Your taxes get redistributed for the greater good of the economy. Thank you for your service!
- Consider working less for greater happiness. If you’re the sole-income earner making over $400K, I highly recommend taking things down a notch if you are feeling overly stressed. This unhealthy desire for prestige and money is going to cause burnout and dissatisfaction at home. If you have kids you won’t regret spending more time with them. Neither will they. Your perfect income level might be $400K if you can work less and not have to pay more taxes.
- Make big money now to live like a King or Queen later. Alternatively, if you still enjoy your $400K+ a year job, take advantage until you can’t take it anymore or get let go. Your saving rate needs to go up, preferably to at least 30% to build your passive income streams. In retrospect, I probably should have worked at least one more year to bolster my finances.
- Change the composition of your income. W2 income is taxed at the highest rate and requires the most effort to produce. Therefore, you would be wise to generate more passive income streams that are taxed at a lower rate. If you do, you can earn between 20% – 25% less in income to cover your expenses. But in order to do so, you must get that savings rate up.
- Get into a wealth-building mindset instead. The government goes after income harder. Therefore, you need to concentrate more on building a greater net worth. That said, beware of a potential reduction in the estate tax threshold under President Biden.
- Everybody thinks they know better. Never tell anybody your actual income and expenses because you will receive endless criticism. For example, I’ve read plenty of feedback from childless people judging parents on how to parent and spend. It makes no sense. The upside to everybody being a financial critic is that perhaps nobody is really hurting financially. If people were struggling, they wouldn’t be criticizing high-income earners. Live the life you want. Remember, you don’t need to win a financial argument. You win by getting rich.
A Comfortable Life Is All We Want
I gave up a six-figure income in 2012 because I was burned out. I also realized that I was happy living on much less. My out-of-shape boss, who probably made close to $1 million a year, was not someone I aspired to be.
My household is happy with a middle-class lifestyle. This is why we are shooting to earn $300,000 a year in passive income. $322,000 is about what the California Association Of Realtors deems as the required minimum household income to afford a median-priced house in SF. Therefore, I use their estimate as our retirement income barometer.
Given we paid off our primary residence, we don’t need as high of a household income to live comfortably. However, it’s still fun to have goals. Although $300,000 is way less than the income I feel is necessary to qualify as unequivocally rich ($1M), what we lack in income, we make up for in time. Further, passive income is taxed at a lower rate and doesn’t require working ungodly hours.
I’d much rather be poorer and free than having to work at a job I don’t love. If you are making $400K+ and are not happy, please make some changes. Paying higher taxes while being miserable at your job is no way to live.
Personally, I plan to re-retire within the next 12 months after everybody in my family is inoculated. I’m proud to have paid lots of taxes helped support all the stimulus packages. Further, I’ve been paying full healthcare premiums of $2,250/month so far. However, I’m tired of the grind and want to finally take things down a notch.
Very soon, it will be time to enjoy life to the fullest as the economy reopens!
Earn More Passive Income Through Real Estate
Changing the composition of your income is important if you are facing higher taxes and working too much. Therefore, I highly recommend building a real estate portfolio. Real estate is a much more tax-efficient way to earn income. Not only is real estate a more stable asset class than stocks (see March 2020 stock market meltdown), real estate also provides shelter, and is a beneficiary of inflation.
Thanks to the ability to deduct rental property expenses and the non-cash amortization expense, your tax bill goes way down or often disappears as a rental property owner. Further, in a low interest rate environment, the value of income is more valuable because it takes more capital to generate the same amount income.
If you don’t want to physical own rental properties to generate income, take a look at my two favorite real estate crowdfunding platforms. They are free to sign up and explore. Real estate crowdfunding is a way to own various types of property around the country and earn income 100% passively.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. These cities potentially have higher growth due to job growth and demographic trends.
I’ve personally invested $810,000 in real estate crowdfunding across 18 projects. My goal is to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.