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Why The Ideal Income Is The Student Loan Forgiveness Income Threshold

Updated: 11/10/2022 by Financial Samurai 60 Comments

Have you ever wondered what the ideal income is to live a comfortable life before retirement and after retirement? Well, look no further than the student loan forgiveness income threshold of $125,000 per individual and $250,000 per married couple.

On August 24, 2022, President Biden unveiled a plan to cancel up to $10,000 tax-free in federal student loans for borrowers who individually earn less than $125,000. $125,000 is a generous income threshold given the median household income is about $75,000 in 2022.

For lower-income individuals who received Pell Grants, they will be eligible for up to $20,000 tax-free in student loan forgiveness. You can even get a refund for any payment (including auto-debit payments) you made during the payment pause, beginning March 13, 2020. Finally, President Biden will also extend a pause on federal student loan payments for what he called, “the final time” until December 31, 2022.

The plan could bring relief to over 43 million borrowers with an average of $30,000 debt outstanding. More details from the White House can be found here.

Whether you believe forgiving student loans for individuals making up to $125,000 is right or wrong, we must accept the government has the power to do what it wants. Society is all about giving and taking.

For background, I went to William & Mary and paid in-state tuition because that’s what we could comfortably afford. At the time, tuition was $2,800/year versus $22,000/year for a comparable private university.

Student Loan Forgiveness Income Threshold Is The Ideal Income For Most

The Ideal Income To Earn While Working

The ideal income where making more doesn’t provide more happiness has been hotly debated. But the government has revealed to us the answer. The $125,000 income threshold for individuals and $250,000 income thresholds for married couples reveals to us the upper boundary of who the government views as middle class.

The middle class is the best class because it is the protected class that gains the most favor from the government. The middle class makes enough to live a comfortable lifestyle without the need for subsidies. We’re talking about making enough to own a house, own a car, have two kids, and save for education and vacations.

At the same time, the middle class is always eligible for subsidies, such as student loan forgiveness, stimulus checks, and child tax credits. Why? Because politicians rely on the biggest demographic group in the country to stay in power.

Holding Onto Power

One main goal of a politician is to stay in power for as long as possible. Once you have power it’s hard to let go. Power is intoxicating and can set your friends and loved ones up for life. Power is also the reason why billionaires enjoy buying media companies.

This combination of having your cake and eating it too is one of the reasons why wealthier households like to claim they are also middle class. Learning how to convince people you are middle class when you’re rich is a skill worth learning.

Who doesn’t want to feel like they belong to a larger group the government always supports? Nobody wants to feel persecuted for earning or having too much. We all want to be middle class, whether we truly are or not.

The tricky situation every politician faces, however, is determining what income cutoff is eligible and ineligible for free money. Deciding this income threshold for a redistribution of tax dollars is carefully decided by a team of strategists, economists, and advisers. They didn’t just one day come up with $125,000 / $250,000 out of thin air!

Determining The Income Threshold Is Tricky

If the income threshold for free money is too high, then enough people will start grumbling that politicians are providing tax cuts and free money to the rich. Since most politicians enter the office rich and become much richer after leaving, they don’t want to make it too obvious their policies are also helping themselves and their friends.

If the income threshold for free money is too low, then politicians won’t be able to effectively buy enough support to remain in power. Let’s be honest. The vast majority of people would vote for someone if the candidate promised to give them a free $1,000, let alone a free $10,000 – $20,000. Observe what people do with money not what they say.

We’ve seen this income threshold debated in the past when President Obama wanted to raise taxes on anybody making over $200,00 and any household making over $250,000. In his administration’s eyes, folks who made more were considered rich. Eventually, there was a compromise.

Perhaps due to inflation and an increase in overall wealth, President Biden has raised the income threshold for higher income taxes to $400,000 per individual and $450,000 per household. If the student loan forgiveness plan goes through, then it sets a strong precedent for higher income taxes to come.

The Ideal Income To Earn In Retirement

Given the ideal income to earn while working is between $125,000 and $250,000, then the ideal income to earn in retirement is roughly the same. After all, most of us would love to live the same lifestyle or better once we no longer have to work.

However, the great thing about successfully retiring is that we no longer need to save for retirement. This is one of the biggest realizations many retirees have told me after decades of saving 20% – 50% of their incomes.

When you no longer need to save for retirement in retirement, you free up a lot of cash flow. Further, we should be able to spend 100% of our retirement income or more if we plan to decumulate and not die with too much.

Therefore, the ideal income to earn in retirement is closer to $100,000 per individual and $200,000 per couple. At these income levels, the government will unlikely increase your taxes or cut you out of subsidies.

Finally, retirement income usually comes from investments, pensions, and Social Security, which have more favorable tax rates. Below is a chart that shows you can earn up to $41,675 as an individual and pay no long-term capital gains tax.

Long-term capital gains tax rates

With $100,000 in passive retirement income a year per person, you should be able to live like a king or queen for the rest of your life!

Capital Necessary To Generate The Ideal Retirement Income

If you agree the ideal retirement income is about $100,000 per person in America, then how much capital is necessary to generate such an income level? To find out, we simply divide $100,000 by various rates of return.

To generate $100,000 a year in passive retirement income, you would need the following invested capital:

$10 million at a 1% rate of return

$5 million at a 2% rate of return

$3.33 million at a 3% rate of return

$2.5 million at a 4% rate of return

$2 million at a 5% rate of return

$1.66 million at a 6% rate of return

$1.43 million at a 7% rate of return

A reasonable rate of return in retirement is somewhere between 2% and 5%. The last thing you want to do in retirement is take too much risk, lose a lot of money, and have to go back to work. Therefore, most people will likely need between $2 million to $5 million in invested capital to generate the ideal income in retirement.

I’ve written in the past how having a net worth of $10+ million is the ideal net worth in retirement. It’s what the majority of you voted on. However, based on government analysis of the student loan forgiveness income threshold, $10+ million is probably too much.

You Don’t Need The Ideal Net Worth Or Ideal Retirement Income

Now obviously, not everybody needs to earn $100,000 in annual retirement income to have a great life. We’re talking about the mass market ideal here.

If you’re happy spending $50,000 a year gross per person in retirement, then all you need is $1 million to $2.5 million in invested capital at a 2% to 5% annual rate of return. Plenty of retirees live happily on less if they have no debt and proper health insurance.

If you’re happy spending $30,000 a year gross per person in retirement, then you’ll only need $600,000 to $1.5 million in invested capital.

With the average Social Security payment of around $20,000 a year, you may only need $200,000 – $500,000 in invested capital to generate $10,000 a year in retirement income. Very doable after 40+ years of working.

The cost of attending college and federal support

People Retire In Different Ways

I profiled a woman who retired with a net worth of only $600,000 and relocated to Taiwan to teach English. She started a new life partly because she wanted to escape the money trauma endured in America. So far, she seems to be having a great time living on a lower budget.

On the other end of the retirement spectrum, I profiled a man who gave up a $300,000+ job at 41. He retired with a net worth of $4 million and has two young children. Instead of lowering his household budget, his strategy is to support his wife in her career endeavors.

If you’re able to earn some supplemental retirement income, like I hope all retirees do, then you’ll need even less capital. The supplemental income fills the gap between your retirement income and your desired living expenses.

But more importantly, doing some work that provides meaning and purpose keeps life interesting. Personally, I’m much happier when I have a purpose. Purpose is partially why I continue to publish three times a week on Financial samurai.

Use Government Policies As A Guide To Live A Better Life

One of the reasons why I felt more comfortable leaving work in 2012 was due to an upcoming change in tax rates. There was a new surtax of 3.8 percent on income from investments coming up in 2013. Further, the highest marginal income tax rate was going up to 39.6 percent from 35 percent.

In 2012, I was exhausted and bored with my job. Therefore, it didn’t sound appealing to continue working 60 hours a week and pay more taxes. So instead of complaining, I negotiated a severance and changed my life. As a result, I became happier even though I was making a lot less money.

Never complain for more than a moment. Do something about a suboptimal situation.

Don’t change your life due to upcoming government policies. That’s the tail wagging the dog. Instead, use government policies as a guide to make marginal improvements. Government policies were at most 10% of the reason why I wanted to leave finance.

Marginal Differences In Effort With Different Presidents

With my belief that Obama would remain in office until 2017, I assumed there would be a bigger government safety net. Therefore, it felt safer to take things easier when you don’t have to try as hard to take care of yourself. Worst case, I felt I wouldn’t starve to death with a bigger government.

When Trump became president on January 20, 2017, a part of me felt I needed to work harder. The five years since I left my day job were a nice respite. However, over the next four years, I assumed there would be a shrinkage of the government safety net along with lower taxes. With the birth of my son in April 2017, I decided to step on the gas.

Now with President Biden fulfilling his campaign promises, I feel it is rational to take things down a notch again. Higher tax rates are most likely coming to pay for more government subsidies. Hence, if you’re burned out and making over the ideal income of $125,000 per person, you should feel less guilty taking things easier as well.

Making over $125,000 per person in America won’t make you much happier. Neither will making more than $200,000 per person if you live in an expensive coastal city. In many circumstances, making much more than $125,000 will make you unhappier given the stress and long hours that are often required to make such an income.

The student loan forgiveness program comes at a time when millions of people are exhausted after two-and-a-half years of the pandemic. The next presidential election is on November 5, 2024. If you need a break, utilize the next two years to recharge. At least join the quiet quitting movement and gain back your sanity.

However, in the event the recession deepens, please act rationally to protect your finances. The government can only do so much. In the end, it’s best for you to depend on yourself to win. If free money comes your way, rationally take it and be thankful. If not, you never expected it in the first place.

Update Nov 11, 2022: A federal judge rules that President Biden’s plan to cancel hundreds of billions of dollars in student loan debt is unconstitutional and must be vacated. Sorry folks. No student loan forgiveness after all.

Reader Questions And Action Items

Readers, what are your thoughts about the student loan forgiveness program? Do you think the income threshold of $125,000 per person to receive student loan forgiveness is appropriate? If not, what do you think is a more appropriate income threshold, if any? What do you think is the ideal income while working and in retirement?

If you enjoyed this discussion, pick up a hardcopy of my WSJ bestseller, Buy This, Not That. Not only will the book help you build more wealth, but it will also help you tackle some of life’s biggest dilemmas in a logical way.

For more nuanced personal finance content, join 50,000+ others and sign up for the free Financial Samurai newsletter. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009.

Lending Money To Friends And Family: How To Determine When It’s OK

Updated: 11/30/2022 by Financial Samurai 17 Comments

One of my tennis buddies told me a funny story about borrowing money from his parents. He was 28 at the time and asked for a $30,000 loan to buy a condominium. Since his parents had the spare cash and weren’t making much from interest, they figured lending money to him was a win-win situation.

All was going well until one day, his mother came over to his newly purchased condominium. It had been a while since they moved in and his mother wanted to have a talk about the lent money.

The mother said, “Paul, your father and I are disappointed in you. It’s been three months since you borrowed our money to buy your condominium and you haven’t paid us anything back. What is going on?”

My tennis buddy replied, “Mom, I had no idea you wanted to get paid back so soon. We’ve been busy furnishing the place and stuff. I guess we should have written down some parameters regarding how you would get paid back!”

Then his mom replied, “Yes, you should have been more considerate about paying us back something every month. We worked very hard for this money and it was supposed to be for our retirement. However, your dad and I talked about it and we’ve decided to forgive the $30,000 loan as a wedding present.”

This is when my friend said he almost burst a capillary in his forehead, “No mom! After the guilt you just gave me, there’s no way I’m accepting your money!”

He then stormed to his room, made some calculations, and gave her a check that paid back some interest and principal. There was no way he would let his mother lord over him like that. He was pissed.



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Why Fed Rate Hikes Will Have Little Impact On Borrowing Costs

Updated: 03/26/2022 by Financial Samurai 23 Comments

After three years, the Federal Reserve has finally begun hiking rates to help stem rising inflation. With the latest 7.9% inflation print, inflation is now at a 40-year high.

The Federal Reserve has telegraphed it will hike the Fed Funds rate 6-7 times over the next 12 months. Therefore, we could easily see 1% – 1.75% higher Fed Funds rates in the near future.

The Fed is behind the curve when it comes to hiking rates. And that’s understandable. The Fed would rather be a little too slow in hiking rates than a little too fast in order to help our economy survive a pandemic.

Put another way, which would you rather have, higher inflation and a stronger labor market, or lower inflation and a weaker labor market? The former is usually preferred. In an ideal world, the Fed would love to have 2%-2.5% inflation and 3.5% – 4% unemployment levels.

But the reality is, the upcoming Fed rate hikes will have a negligible impact on your finances, especially if you have been a regular Financial Samurai reader. Fed rate hikes won’t make borrowing costs that much greater. Therefore, for those of you who like to take out credit card debt, auto loans, student loans, and mortgage rates, I wouldn’t worry too much.

Let’s break down how Fed rate hikes will affect borrowing costs for each category.



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Negative Real Mortgage Rates Means Don’t Pay Down Extra Principal

Updated: 08/07/2022 by Financial Samurai 51 Comments

As a homeowner with a mortgage, the holy grail is having a mortgage rate below the 10-year bond yield. When you have this situation, it’s like living for free and you should not pay down extra principal. If you had the money, you could invest an amount equal to your mortgage into a 10-year Treasury bond. The interest income can then be used to pay your entire mortgage interest.

The second best situation is having a negative real mortgage rate thanks to inflation and low rates. In such a scenario, although you can’t technically live for free, from an inflation-adjusted standpoint, you kind of are. You shouldn’t be in a rush to pay down debt.

To see if you have a negative real mortgage rate, take your mortgage rate and subtract it by the latest inflation rate. If the percentage is less than zero percent, then you have a negative real mortgage rate. If you have a negative real mortgage rate, you should also slowdown or stop paying extra principal because you’re borrowing free money.



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The Average Credit Score In America Is Now Excellent

Updated: 08/09/2021 by Financial Samurai 58 Comments

The average credit score in America is now 710 according to Experian. Back in 2019, the average credit score was 703.

In other words, during a global pandemic, the average American improved their wealth and their financial health. Not only has the average credit score in America improved, the average saving rate has also improved from 6% to over 10%.

The Average Credit Score In America Is Now Excellent

When the U.S. saving rate surged in 2020 to a high of 32%, so did lending standards.

Lending Standards Are Tightening

During a previous mortgage refinance in 2019, my loan officer said that he hadn’t worked with a borrower with under an 800 credit score in over two years. I was surprised to hear this because I clearly remember banks offering the best refinance rates when you had at least a 760.

At the beginning of my refinance process, the mortgage officer asked whether I had over an 800 FICO score. I told him I thought so. But I felt like I had been caught in a lie because I didn’t know for sure.

However, if I had said “no,” I felt like he would have hung up on me. He gave me this “you better not be wasting my time” vibe.

With the mortgage industry even tighter today thanks to so much demand, borrowers must really have their financial ducks in order to get the best rate.

For those interested, let’s review the fundamentals of the credit score.



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Can Your Finances Withstand A Fed Rate Hike?

Updated: 09/02/2022 by Financial Samurai 62 Comments

Can your finances withstand a Fed rate hike? The Fed Funds Rate (FFR) is at 0% – 0.25% to help combat the recession and global pandemic. However, now the Fed is aggressively raising rates to fight 40-year-high inflation rates.

Usually, when the Fed raising rates so aggressively, risk-assets sell off. Therefore, it’s important to solidify your finances during a Fed rate-hike cycle. Eventually, stocks tend to perform well again after Fed rate hikes, but it may take a while.



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Destroy Debt Quicker: An Easy And Painless Way To Be More Free

Updated: 02/16/2021 by Financial Samurai 57 Comments

A fun and easy way to pay down debt quicker

Do you want to destroy debt quicker? You’re in luck because I have the best way to destroy debt quicker and boost your wealth faster.

If you haven’t noticed, we live in a consumerism society where we are bombarded by advertisements that compel us to spend on things we don’t need. Some things are definitely worth spending up on. But for everything else, save your money.

Like many people, I have debt. Although my debt is tied to property, which tends to appreciate over time, it’s still debt that I plan on getting rid of by 2027. I don’t have any revolving credit card debt because their interest rates are absurdly high.

Earlier this year, I got rid of $815,000 of debt by selling a rental house for roughly 30X annual gross rent. I don’t miss the rental income because I don’t miss the $3,400 monthly mortgage, the $23,000 in annual property tax, the $3,000 in annual maintenance, the $2,000 in annual insurance, and pain in the ass tenants.

Despite the large pay down, I still have about $1,000,000 in debt spread between my primary residence and my vacation rental in Lake Tahoe. Simple math states that if I can pay down $100,000 a year, I will be debt free in 10 years.

Here’s an easy strategy for how I plan to get there relatively painlessly that I recommend you follow as well.



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Pay Down Debt Or Invest? Implement FS DAIR

Updated: 02/11/2022 by Financial Samurai 104 Comments

The decision to pay down debt or invest is a personal one. It depends on a lot of factors such as risk tolerance, your number of income streams, liquidity needs, family expenses, job security, investing acumen, retirement age, inflation forecasts, and bullishness about your future in general.

I’ve had hundreds of people ask me whether to pay down debt or invest over the years. As a result, I came up with the Financial Samurai Debt And Investment Ratio, or FS DAIR for short back in 2014. Despite interest rates plunging since then, the FS DAIR framework still holds up strong.

The FS DAIR formula for deciding whether to pay down debt or invest is as follows:

Debt interest rate X 10 = percent of cash flow after living expenses allocated towards debt pay down

In other words, if you have a mortgage with an interest rate of 3%, utilize 30% of your monthly cash flow after living expenses each paycheck to pay down debt. Invest the remaining 70% of your cash flow based on your investment preferences.

If you concurrently pay down debt and invest, it’s very hard to lose in the long run. Ultimately, it’s best to be debt-free when you retiree or no longer have the desire to work.

As the CFO of our own finances, it’s up to us to figure out the most efficient use of capital. With FS DAIR, you will approach paying down debt or investing in a rational manner.  



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How Student Loan Forgiveness Can Cost You A Fortune

Updated: 03/21/2021 by Financial Samurai 48 Comments

After publishing my post on actions to take in a rising LIBOR environment, it dawned on me that besides refinancing your adjustable rate mortgage, you should also consider refinancing your student loans as well, if you have any. It feels like a lifetime ago, but I used to have ~$40,000 in business school loans that were paid off in 2008. Student loan forgiveness can actually cost you a fortune. 

During my time, there was no such thing as student loan forgiveness. Come hell or high water, you had to pay back what you owed with interest. You also couldn’t go straight to the corner office without paying your dues either. As our country has grown wealthier, softer, and more focused on instant gratification, student loan borrowers have pressured the government into giving them more options and it’s worked! 

Here are some various options borrowers have to repay their loans and how student loan forgiveness can actually end up costing a borrower more. I had no idea there were this many choices. I’m hoping by the time my kids go to college in 20 years, tuition will be free or highly subsidized, just like it is in Europe, Asia, Canada, and the rest of the world. It’s fun to have someone else pay!



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The Best Strategies To Get Out Of Debt And Become Happier In The Process

Updated: 03/21/2021 by Financial Samurai 58 Comments

Out of debt with not a care in the world

Let’s look at the best strategies to get out of debt. Once you get out of debt, you will likely become happier because you will feel less financial burden.

I graduated from business school in 2006 with roughly $55,000 in student loans. Although $55,000 is a lot to pay off, I was already a “debt veteran” by then. What’s another $55,000 in student loans when I was already leveraged over $1 million dollars to buy my first properties in 2003 and early 2005?

I didn’t need to take out student loans, but I decided to conduct some financial arbitrage. The maximum amount one could borrow through a Stafford Loan at the time was $18,500 a school year at an interest rate of 2.75%-4%.



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