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.
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.
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.
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.
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