One of the great things about America is freedom. Tired of feeling like death living in Chicago, New York City, or Boston during the winter? Why hello San Diego, Miami, or Honolulu! Not feeling there are enough job opportunities for advancement in Detroit? Then come on down to San Francisco! Tired of eating healthy food in San Francisco that costs an arm and a leg? No city can beat the wonderful soul food of New Orleans.
Geo-arbitrage is a term where one can earn and save money in one place and move to a cheaper location to maximize their money. If you happen to own an internet business, then your ability to geo-arbitrage is greatest. I’ve often thought about just relocating to Thailand for several months at a time given friends say they live extremely well off $2,000 a month for two. Given one of my goals is to take 100 hours of intensive Mandarin lessons, I may very well be writing to you from some lower cost country in the future.
75% of the audience comes to Financial Samurai through a search engine like Google. They have a financial problem they are trying to solve. This is huge because it takes initiative to come to grips with one’s finances. But what I’ve noticed over time is that besides the middle class getting pissed off about the widening wealth gap, upper-income earners are also feeling some angst as well.
Over 50% of singles readers and 74% of household readers make over $100,000 a year based on my Financial Samurai income poll (14,000+ so far down below). As a result, I’d like to delve into analyzing how a “typical” $200,000 a year household spends their income. A six figure salary can range from $100,000 to $999,999, so I figure I’d start on the low end for two people. $200,000 is a comfortable household income, but I don’t think it can qualify as rich.
MAKING $200,000 A YEAR AND STILL FEELING AVERAGE
This lovely family of three living in San Francisco, with two working parents making $100,000 each (hooray for income equality!) are left with roughly $5,700 a year in disposable income after expenses and 401k contribution. Given their total cost is $121,700 after tax a year, that’s roughly $10,000 a month they’re spending.
I can hear the detractors now. So let me preempt your complaints by addressing them up front.
They took out a $640,000 mortgage at 3.75% after putting down $160,000 for a two bedroom, two bathroom single family home in the outer regions of San Francisco. Their payment is therefore $3,000 a month, or $36,000 a year. 70% of their $36,000 mortgage is interest. Hence, Take 70% X $36,000 = $25,200 a year in interest they are paying which is deductible from their $200,000 gross salary.
The family now has $18,000 (401k) + $25,200 (interest) in deductions. To make math easier, let’s just take the $25,200 in interest and multiply it by their federal marginal tax rate of 30% (they straddle the 28% and 33% federal income tax bracket) to get $7,560. In other words, when they file their taxes they should get roughly $7,560 back on top of the $5,700 left over they are saving.
This family now has roughly $13,260 in disposable income after maxing out their 401k after they file their taxes. For every year they work, they can save a little over one month in living expenses before they feel great strain. Their effective tax rate is probably closer to 27% than the stated 30% in the chart.
Yikes! Childcare is expensive. The average cost of center-based daycare in the United States is $11,666 per year ($972 a month), but prices range from $3,582 to $18,773 a year ($300 to $1,564 monthly), according to the National Association of Child Care Resource & Referral Agencies (NACCRRA).
OK, so my $24,000 childcare estimate is high. But it is high because I also asked five friends in San Francisco who have kids in childcare and that’s what they say they pay. Remember, averages don’t properly estimate the true costs in many departments. Besides, I haven’t even included the cost of private school tuition as an option!
Two Vacations A Year: $8,000
Damn, Gina! What kind of vacations cost $4,000 each for a family of three? How about a good old fashion staycation, or camping in the woods for $200 bucks instead? I’m a big proponent of staycations and road trips, especially now that gas is so cheap, but this is a hard working couple who only have four weeks of vacation a year. Their time is so valuable that they want to live it up when they can.
Let’s see, three roundtrip tickets to Maui from San Francisco costs around $750 each during peak season (goes up to $1,200 actually). That’s $2,250 on airplane tickets right there. Lodging costs $300 a night after tax for something very average. That’s $2,100 for a week’s hotel stay for a total of $4,350. Meanwhile, the family hasn’t even eaten or paid for any type of fun activities yet! The total cost of a two week vacation to Hawaii can easily go over $6,000.
Let’s say the family decides to be a little frugal for their remaining two weeks of vacation by renting out the one bedroom portion of my two bedroom condo in Lake Tahoe this summer. The price is an internet low $195 a night (vs. $250+) + the $25 Resort fee, cleaning fee, and taxes. The total price comes out to $1,708 for check in July 9, check out 7/16 for seven nights. Now let’s add on $50 for gas round trip. Add on $600 for food and fun and we’re talking only $2,358 for a week in one of the most beautiful places to go during the summer.
Car Payments: $6,000
What a waste! But a $500 a month car payment (after tax and fees) is so common for many Americans nowadays given the median price of a new car is $32,000. I was considering leasing a $41,000 Jeep Grand Cherokee Limited for ~$500 a month, but decided to go for my dream car, a $19,025 pre-tax 2015 Honda Fit instead.
A $500 a month car payment (based off a $5,000 downpayment, another big waste of money) allows one to drive a BMW 3 series, Mercedes C-class, Lexus IS250, Audi A4, and a Jeep Grand Cherokee. These cars are definitely a notch more luxurious than your Honda Accords and Toyota Camrys ($21,000 – $26,000) and so forth. But a $40,000 – $50,000 BMW 3 series is pretty common for a family making $200,000 a year, even though I recommend a family should spend no more than $20,000 for a car. Just read the 500+ comments in my post on the 1/10th Rule For Car Buying Everyone Must Follow and see for yourself.
$4,800 a year on gas seems high now that gas prices have plummeted. So let’s say the $4,800 includes all transportation costs, including bus fare, taxi rides, Ubers, and gas. If you are looking for affordable auto insurance, check out eSurance for a no obligation quote. They are owned by Allstate and have some of the cheapest car insurance rates online.
Student Loans: $0
A lot of readers who make this income level have pointed out in the comments that this couple is lucky because they don’t have any student loans. They are right! They paid for their education along with the help from their parents. But if you do have student loans, I would definitely check out SoFi to refinance them.
SoFi is one of the leading new financial technology companies based in Silicon Valley that not only reviews your credit score and income/debt ratios, but also looks at the quality of your education and quality of your work institution. If you’re right out of school, you’ve got a lot of upside, but perhaps your finances don’t look so great.
Taxes: 30% effective
A 30% effective tax rate is realistic for a $200,000 income earner. The married couple is at a 24% marginal federal tax rate as of 2018. If they were to only pay federal taxes, the effective tax rate is closer to ~22%. But they live in California, where they face a state income tax rate of 9.3%!
But, oh yeah, they also have to pay FICA tax on wages up to $128,400 for 2018. That’s another 6.2% for Social Security + 1.45% for Medicare = 7.65%. It’s easy to see how the total effective tax rate is about 30%.
Thank goodness they have $25,200 a year in mortgage interest they can use to lower their taxable income by that same amount.
Property Taxes: $8,000
The family lives in San Francisco and pay a property tax rate of 1.24% on the assessed value of their property. They bought property for $650,000 a year ago, and the city has assessed the property at $667,000. Due to Proposition 13, property values can only be assessed by an index that rises no greater than 2% a year, even if the property might increase in value by 20%. If they were to sell their property now, they could probably get $700,000 or more since San Francisco prices have continued to go up.
Take advantage by refinancing your mortgage with LendingTree. They have one of the largest lending networks on the web. Even if you don’t go through them, since there’s no obligation, you can use the various bids made to you as leverage to get your existing bank to match or beat their rate. When banks compete, you win.
Healthcare Expenses: $$$
Employers generally subsidize your healthcare premiums through a group health insurance plan. The cost can range from $0/month – $800/month for a family. It all depends on how generous your employer’s benefits are.
College Savings: Whatever is left over
Another missing item from the spreadsheet is college savings. Like most families with young kids, they aren’t putting aside a specific amount of money yet because they’ve still got 10-15 years to go. They’ve decided to just focus on saving for their retirement first in their 401k and after-tax brokerage account like Wealthfront, which charges minimal fees. Parents should also consider contributing up to $14,000 a year in their child’s 529 College Savings plan as soon as they are born. When the time comes for their kids to go to hopefully public school, they’ll draw from their savings and brokerage accounts to pay as they go.
Don’t Let Money Rule Your Life
I read some study that in order for you to feel rich, you have to make 3X as much as you currently make, no matter what you make. So if you’re making $50,000 a year, $150,000 a year in income will make you feel like making it rain at the clubs. But if you’re making $150,000 a year in income, you won’t feel rich until you make $450,000 a year. In other words, human beings don’t ever seem to be satisfied with what they have.
What we like to do is project our emotions onto other people. So for all those people making less than $52,000 a year, it’s easy to say any household making $200,000 a year should feel rich and should shut the hell up about paying a progressive tax rate.
Making as much money through non-wage income (W2) is what it’s all about.
The family in my example is going to live a nice and comfortable life, no doubt. After 20 years of work, they’ll likely have saved over $500,000 in their 401k, and perhaps another $100,000 in after tax investments and savings, even if their $200,000 income stays static.
Nobody is going to cry for them. I just don’t think this family will ever feel rich, just comfortable since they have to keep on working and paying an ever increasing tax rate.
MANAGE YOUR FINANCES IN ONE PLACE
Get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize your money. Even at a high income, money escapes like water from a leaky bucket if you don’t carefully track where it all goes. Before Personal Capital, I had to log into eight different systems to track 30+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances on an Excel spreadsheet. Now, I can just log in to see how all my accounts are doing, including my net worth. I can also see how much I’m spending and saving every month through their cash flow tool.
The best feature is their Portfolio Fee Analyzer, which runs your investment portfolio(s) through its software in a click of a button to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was hemorrhaging! There is no better free financial tool online that will help you build your wealth for financial freedom.
Updated for 2018 and beyond. It’s now more important than ever to track your finances because the easy money has already been made.