Can you imagine scraping by on $500,000 a year? Well, believe it. Thousands of households living in expensive cities are running on this never-ending treadmill. It's only when you can lock down expenses, save and invest aggressively, will you ever escape the rat race.
They've got big mortgages, private school tuition to pay, and fancy cars to drive. No matter how much they make, these households tend to spend all their income and not save as much as they should. Now with inflation running near 40-year highs, important costs are simply going up further.
I'vehighlighted in a previous article how living off $200,000 a year in an expensive city is really just an average lifestyle. In this article, I'll discuss how one couple is living paycheck to paycheck while making a combined$500,000 a year.They are a real couple who shared with me their financial details to anonymously share with you. Judging others, after all, is an American pastime!
$500,000 a year or higher is a level which I think is considered rich. Anybody who thinks otherwise has no concept of financial reality. Even the government agrees after compromising by raising the income level for when the highest marginal tax bracket kicks in to ~$400,000 from $200,000 back in 2013.
But starting in 2018, things got even more painfulfor the upper middle class. The SALT tax cap capped mortgage interest deduction and limited property tax deduction to $10,000.
Now Joe Biden is looking at raising taxes for households making over $400,000. Can you imagine working 60+ hours a week, never seeing your family, and still paying more in taxes?
No wonder why more high-income households are looking to retire early and enjoy the YOLO Economy to the maximum. Life is short and this pandemic has really motivated millions to finally live it up!
Who Makes $500,000 A Year? Household Combinations
Although making $500,000 a year may sound like a Herculean task, you'll be surprised to know there are plenty of regular folks who hit the half million mark every year. Here are some combinations.
1) A couple 30 year old lawyers in their fourthyear at a big law firm
2) A couple 32 year old second year associates at an investment bank after business school
3) A single 31 year old VP at a private equity shop twoyears out of business school
4) A 35 year old senior project leader at a management consulting firm and her schoolteacher husband
5) A couple 35 year old doctors (cardiologist and anesthesiologist) three years aftertheir fellowships
6) A 46 year old Chief Marketing Officer and her 52 year old police officer husband
7) A coupleonline marketing consultants in their mid-30s
8) A 41 year old super frugal personal finance blogger who preaches riding a bike, doing your own home construction, and living off $30,000 a year or less and his wife
9) An engineer at Google who has been there eight years and his partner at Salesforce
10) A 22 year old rookie professional basketball or football player and his product manager wife.
11) A junior partner at a law firm and her Silicon Alley engineer husband
12) ABay Areajanitorand hiselevator technician spouse
As you can see from my examples above, plenty of professions make $500,000 a year or more in household income at a relatively young age (<40). Finances are much easier when you combineforces! Some are scraping by and some are doing just fine.
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How To Make $500,000 And Never Escape The Rat Race
People who consistently earn $500,000+ annually should not have any financial problems. If they are scraping by, they aren't getting sympathy from anybody since they're making roughly 6.7X the median household income of $75,000.
A very simple solution to growing rich is to simply track your finances for free online. The process is similar to how you'd track your weight by stepping on a scale at least once a week to keep yourself honest. The free tool I've used to manage my wealth since 2012 is Empower.
Just beware. Money can be intoxicatingly evil once the big bucks start rolling in. As soon as you start making multiple six figures, you begin associating yourself with other people who make similar amounts or much more.
Remember, it's nice making max money in the NBA. But it's even nicer if you are the owner who can cut max money checks!
We're Always Comparing Ourselves
There’s a never ending cycle of financial comparison. And with comparison comes envy, jealousy, depression, loneliness, and all sorts of feelings that would not be felt if you just took a step back andrealized how fortunate you really are. If you try to keep up with your neighbors too much, scraping by may be inevitability, no matter how much you make.
This is why if you do want to beat the Joneses, you shouldcompete on FREEDOM. After all, there will always one more dollar to be made. If you don't compete on having the most freedom, scraping by might very well be your reality with a high income.
The below chart is an annual spending example of a couple who each make $250,000 a year as lawyers. They have two children ages threeand five. They are both in their early 30s and live in New York City, the most expensive city in America! One could say they are scraping by with just $7,300 left a year in cash flow.
$500,000 INCOME ANALYSIS
Largest Expense: Taxes ($185,600, ~39% effective tax rate).
The number one reason why high six-figure income households are scraping by is due to taxes. It's more efficient to earn investment income than W2 income due to lower tax rates.
The government doesn't believe in two high-earning working spouses. They want one spouse to stay at home and take care of the kids. If they didn't, why did President Obamacampaign aggressively for $200,000 + $200,000 = $250,000 before taxes go up for the top? Equality would dictate that $200,000 + $200,000 = $400,000, which is the compromise our politicians made.
Living in NYC is expensive due to Federal (37% marginal tax bracket), State (10%+), City (4.25%+) taxes, and FICA tax of 6.4% for the first $142,800 you make for 2021. Unfortunately, NYC is where many of thejobs are.
The rich are clearly paying more than their fair share of income taxes. In 2021, the top 1% of income earners in America accounted for “only” 26% of the country's total income, yet they shouldered 46% of the total tax burden. This indicates that the wealthy paid 15% more than what would be considered their equitable share.
At Least No More Marriage Penalty Tax!
This couple use to be paying roughly $8,000 – $10,000 extra a year due to the marriage penalty tax, which is now no more for individuals who turn into couples earning up to $300,000 each.Furthermore, they have AMT, an extra 0.9% Medicare tax they have to pay on income over $200,000, andnet investment income tax (NIIT) of 3.8% on income over $250,000.
With tax reform in 2018, only $10,000 of State And Local Taxes (SALT) is deductible per person or per couple. This is a negative for residents in coastal cities like New York and San Francisco where property tax alone can be $18,000 a year based on the median home price of $1.5M.
Further, a taxable income of over $400,000 means a state income tax amount of over $26,000. This couple with $43,000+ in SALT deductions now loses $33,000. Then there is the cap on mortgage interest deduction on mortgages up to $750,000 from $1,000,000.
Further, President Biden is planning on raising taxes on single people making over $400,000 and married couples making over $450,000 if he gets his way. Thankfully, he hasn't yet.
Wise To Invest In Non-Coastal States
Given the high cost of living in big cities like NYC, is there any wonder why investing in the Heartland of Americais becoming a more popular move by savvy investors? Instead of scraping by in New York City, you could live it up in Des Moines, Iowa, whoo hoo!
The Heartland is being rewarded and protected by the government. Further, property valuations are much cheaper and net interest yields are much higher. With technology and telecommuting now widely accepted post-pandemic, more people are migrating to lower cost of areas.
I've personally invested $810,000 in 18 different commercial real estate investments across the country.
My favorite real estate crowdfunding platform is Fundrise, which has diversified funds that invest in rental properties in the Sunbelt. Fundrise manages over $3.3 billion for over 500,000 investors.
Another option is CrowdStreet for accredited investors, which offer individual real estate opportunities. However, before investing in each deal, make sure to do extensive due diligence on each sponsor. Understanding each sponsor's track record and experience is vital. Both platforms are free to sign up and explore.
So far, my returns have averaged 12% a year and my capital is starting to really pay out. Below is my dashboard, which shows over $624,000 in distributions since I started investing in private real estate.
Mortgage Expense ($60,000)
$5,000 a month in mortgage expense bought this family a ~$1,500,000, 3/2, 1,700 sqft condo in Brooklyn a couple years ago. In other words, they are living comfortably, but not large.
Luckily, they bought their condo a couple years ago because similar condos are now going for $1.6 – $1.8 million. I would say a mortgage, property taxes, and maintenance expenses are main reasons for scraping by.
Further, mortgages rates for 30-year fixed, 15-year fixed, and a 5/1 ARM are now close to 6-year lows as the Fed has decided to step off the gas pedal. If you haven't refinanced or check the latest mortgage rates, you can get a free mortgage rate quote to get the best rate possible.
Childcare Expense ($42,000)
Surprise! Children are expensive, especially in big cities. Without children, a $500,000 would likely never be scraping by.
They are actually getting a discountwith two kids, given childcare for one kid costs closer to $30,000 a year. The $42,000 a year cost can be spent on daycare or a day nanny, although some contend that $42,000 is not enough.
If the couple wants to send their kids to private grade school after, then the cost of tuition is often even greater than child care. Here in San Francisco, private high school tuition is over $55,000 a year per child.
Student Loan Expense ($32,000)
Law school tuition runs $50,000 a year for three years. That's $300,000 in law school tuition plusroom and board spent. If they didn't go to law school, they could have easily made $65,000 – $80,000 a year doing something else.
So many people conveniently forget that in order to get a high paying job, it often takes a lot of expensive education. It would be nice if the US education system was practically free as it is in Canada or Europe. Too bad it's not.
It's typical for many doctors and lawyers to have over $100,000 in student debt to pay off over a 10-20 years period. If there's one hack American parents should consider, it's sending them to Canadian universities. Not only are they easier to get in, they are much cheaper as well. Take advantage of Canada as the Canadians take advantage of a more lucrative U.S. job market!
Food For Four ($23,000): A Debatable Expense
Spending $23,000 a year on food means spending roughly $1,916 a month, or $63 a day for four, or $15.75 per person for breakfast, lunch, and dinner. I challenge anybody living in a big city to consistently live off $15.75 a day for longer than three months.
Work lunch alone costs $10-$15 for a mediocre meal compared to $5-6, 10-15 years ago. Therefore, the solution is to buy in bulk and always bring food to work. Unfortunately, that gets old after a while, especially when you're working 60+ hours a week.
Americans are clearly not scraping by on food given the majority of us are overweight or obese. But if we did start to cut down on food consumption, we might get closer to the ideal body weight and live longer.
Car Payments ($9,600): Also A Debatable Expense That Can Be Reduced
With two precious ones, the parents decided to leasetwo family-friendly vehicles: a BMW 5 series and a Toyota SUV with third row seating. $800 a month in lease payments means one less hassle when it's time to get rid of the cars.
They like the convenience of covered maintenance and the peace of mind by having a warranty. They are busy professionals with kids. Car problems arethe last things they want to deal with.
Three Vacations A Year ($18,000): Reasonable!
Let's say each vacation is one week long and costs $6,000. Is that so unreasonable for four people? Seven nights at a 3-4 start hotel costs $300 a night ($2,300 including tax).
Roundtrip airfare for four to debt-laden Puerto Rico costs another $2,400. The family is left with $1,300 to spend on food and activities. It's not like they are flying anywhere via a private jet or anything!
Charity And Alumni Giving ($18,000): Can Be Cut
$18,000 equals 3.6% of the family's gross income, which is inline with the average donationpercentage by incomeaccording to the National Center For Charitable statistics. They each give $7,000 to a charity they strongly believe in, and also give $2,000 a year each back to their respective undergraduate alma maters.
Children’s Lessons ($12,000): Raising Well-Rounded Students
It’s a competitive world out there and these parents want the best for their kids. The kids are taking violin lessons, Mandarin lessons, and tennis lessonsthroughout the year. At an average cost of $1,000 a month, they believe this money is well spent.
How else are they going to be able to get into private grade school that costs up to $50,000 a year? They're feeling the pressure at work, so their kids might as well feel the pressure in school.
Miscellaneous Expenses ($10,000): Something Always Comes Up
Unless you track your finances like the CIA, which you should, something always comes up. If nothing ever came up, you wouldn't have people with less than $5,000 in savings after 10+ years of work. If nothing ever came up, there wouldn't be so manybudget deficits. Sometime unanticipated is bound to happen.
All The Push-backs Addressed
I'm sure by now many of you are wondering what the heck is wrong with this couple? They aren't scraping by. Instead, they are saving for retirement and living a pretty good lifestyle. But how could they earn so much money and be left with so little.
As someone who started his career working in Manhattan in 1999 with a $40,000 salary, and living in a studio with a high school buddy in order to save money, I've wondered the same thing. But let's see if we can understand this couple's point of view.
Here are your most common pushbacks and some further thoughts.
Pushback #1: A 40% effective tax rate is too high!
It does seem a little high given the charitable givings and mortgage interest expense. But due to AMT and mortgage interest deduction phaseouts, this couple isn't getting as big of a deduction as you might think, especially now that SALT deduction is capped at $10,000.
There's probably room to lower the couples effective tax rate by 5% with some aggressive accounting. It all depends on how much risk you want to take. Here's some quick math from an astute reader. Do your own!
- NY State tax : (500K-18K-18K-15850)*0.0685= ~$30,700
- NY City tax: (500K-18K-18K-90K)*0.3648+3000= ~$16,700
- Social Security tax (FICA): 7347*2= ~$14,700
- Medicare: 500K*.0145 = $7,250
- Federal tax: Deductions: (47.4K state local), 20K real estate tax, 18K charity, 41K mortgage interest (This is the third year of the amortization as per your information). Child care tax credit: 1200 -> ~104K
- Obamacare tax: (500K-250K)*.009= $2,250
Total taxes of $175,600, which is not too far off from my $185,600 estimate. The child tax credit phases out after a married couple starts earning more than $110,000. Therefore, my ~40% effective tax rate is pretty darn close to reality. Run the numbers if you don't believe me.
With Biden now as President, expect to see a federal marginal income tax rate go up to 39.7% from 37% for this $500,000 a year household.
Pushback #2: A $1,500,000 home is way too expensive! They should just move.
Yes, $1,500,000 is a lot for almost everywhere else in the world, but in Manhattan, the median home price isroughly $1,280,000 and $1,115,000 in Park Slope, Brooklyn.
Spending 20% more than the median home price when you have a family of four to house isn't that egregious. With selling costs still stubbornly high at 5% – 6%, selling so quickly after buying isn't an optimal move, especially because of the kids.
Real estate prices are a reflection of job growth and income levels. Yes, you can move to Idaho to save on housing costs, but you will have a much more difficult time finding multiple six figure jobs.
Invest in the heartland of America through real estate crowdfunding is a simpler, more efficient way to profit from higher yielding properties. Thanks to the pandemic, the spreading out of America is real.
Pushback #3: Who needs two cars in NYC?
Nobody, really. With an awesome subway system and cheap ride sharing, one car is enough for a family of four.If they cut down on one car, they can save $400/month or $4,800 a year. Not a huge amount, but something.
The chart is an example of an imperfectly optimized financial budget. It has room for improvement. Having a large car becomes important with kids because you want to get away from the city and take their friends too.
Personally, I do think driving a cheaper, older car is much better for your mental health. He won’t worry about it getting dinged or stolen as much.
Pushback #4: $12,000 in music and sports lessons?!
The pressure to get into a private school in cities like SF, NYC, and LA isimmense because of public fund mismanagement and strange lottery systems that don't allow students to attend their local public schools where they pay property taxes.
It'ssad to put kids through the wringerso soon, but I guess the cycle never ends if the parents went through the wringerthemselves. The funny thing is, most parents don’t continue to play sports as adults. So why are we pushing our kids to play sports so much when only about 1% play sports in college
After being a parent of two in San Francisco for six years, I clearly understand the angst and anxiety such households with children face. There is a deep concern for their children's futures because of how competitive society has gotten.
Ironically, the more a household makes, the less likely their child will be able to earn the same amount of money and live the same quality lifestyle. At some point, upward mobility ends.
Pushback #5: Having $7,300 left over is still a lot!
It is, if you don't live in a big city with two kids to support. One accident, and that money is gone. This is why having good health insurance, life insurance, and an umbrella policy is so vital. Even then, we hear horror stories about how insurance companies don't fully pay out.
Remember, everything is relative in finance. You can't compare your cost of livingto their numbers if you don't alsolive where they live.
Pushback #6: Three vacations a year? What a joke!
It's sad that we view having three, one week long vacations a year in America as a difficult thing to do.Spend some time working in Europe or Asia and you'll discover how little vacations Americans actually take.
Is there any wonder why countries in Europe, despite their high taxes, consistently rank as the happiest countries in the world? Let's gain more perspective on work-life balance, money, and happiness by visiting other countries.
Pushback #7: At least they are building a 401k balance and home equity.
This is exactly right. When it's time for them to leave the rat race, they'll at least have a sizable 401k balance and a good amount of home equity if real estate continues to increase with inflation. Nothing is a guarantee as we saw during the financial crisis and during 2022, but chances are high their investments and home equity will continue to grow.
The reason why they might not feel rich is because theycan't touch their 401kmoney before 59.5, unless theywant to incur a 10% penalty. Further, given they only own one property, they're neutral the real estate market because theyhave to live somewhere.
Only if they own more than one property are they actually long. They could take out a home equity line of credit (HELOC) to fund their lifestyle, but that's what caused many homeowners to get in trouble in the last downturn.
For 2023, the maximum 401(k) contribution per employee is $22,500.
Pushback #8: Where's the line item for college savings?!
This is where all the cost savings we've conducted so far gets nullified. College tuition now ranges from $20,000 – $75,000 a year. When you add on room and board, we're now talking $35,000 – $100,000 a year for four or five years.
Now imagine how much college costs a year in 10-20 years? Holy crap! Every couple who plans to send a child to college needs to start saving at least $20,000 a year from year one! And that's if you don't plan to send your kids to private grade school.
Private school now costs a fortune. It is also one of the main reasons why high-income earnings are scraping by. It's a rat race to see who can over-educate their children the most!
Make sure to contribute to a 529 plan per child as soon as they are born. The gift tax exclusion amount is now $17,000 per person. You can also superfund a 529 plan now for $85,000. I suggest doing so if you can to get it out of the way.
High Income = Lots Of Stress
If you’re making $500,000 a year in household income as a worker bee, you’re probably going through a lot of stressdue to the amount of hours you are working plusthe amount of taxes you are paying.
You should check out the miserable work feedback from Goldman Sachs analysts. Sure, these analysts will likely make a top 1% income if they stick with finance for over 10 years. However, at what cost?
Making money as a W2 wage slave is the worst way to go. Society won’t acknowledge the sacrifices you made. Nobody will know thetimeand moneyyou spent. Finally, your competitors won't recognize the risks you tookto get to your position today.
The Ideal Income For Maximum Happiness
Is there any wonder why money doesn't buy happiness? Once you make about $100,000 per person in the Midwest, or $250,000 a person on the coast, there is no incremental increase and happiness as you make more money.
A better income strategy and ahappier lifestyle may be awaitingjusta notch below intheupper middle class. When you are middle class, you no longer become a target of society's discontent.
Perhaps you can reduce earnings bydialingbackworkto a more leisurely 40 hours a week. Use the other time doing stuff you enjoy. Or maybe you can start a business so that some of your living expenses can be written off.
I started Financial Samurai in 2009 and it's been my greatest professional pleasure! I also wrote an instant Wall Street Journal bestseller during the pandemic entitled, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. It was my way of making lemonade out of a difficult situation.
I highly recommend you pick up a copy if you want to escape the rat race.
It's Hard To Break Free Without Controlling Expenses
With over $250,000 a year in after-tax expenses, this family must change their lifestyle quite drastically. Even after eliminating 100% of charitable givings, getting rid of both car lease payments, and no longer paying for children's lessons, they've still got $200,000 in annual living expenses to cover!
This couple is saving $36,000 a year in pretax retirement accounts plus $7,000 a year in after tax savings. With a monthly expense of $22,583 to maintain their lifestyle, can you guess how many more years they need to save at their pace to maintain a similar lifestyle in retirement?
At least another 63years! The couple should have at least 10X their $271,000 annual expenses in net worth by age 60.
Here's a handy net worth target chart I've put together for those looking for some wealth accumulation guidance. Due to inflation, low interest rates, and the desire to not outlive your money, try to shoot for 20X your average gross income over the past three years.
If you are part of a household making $500,000 a year, then aim to accumulate a net worth of $10 million dollars a year before you retire. With $10 million dollars, you should be set for life!
Make The Money And Escape!
For those of you who are super ambitious, it's worth working your butt off to see how far you can go in your career. If you get to a multiple six-figure incomelevel, shoot to last for 10 years while saving 50% or more of your after tax income. Eventually, you'll accumulate a large enoughfinancial nest eggwhere you can do whatever your heart desires.
Not a day goes by where I'm not thankful for working brutal hours in my 20s and early 30s. Being free is absolutely priceless the older you get because you no longer are willing to put up with the world's bullsh*t.
After I left Corporate America in 2012 at the age of 34, all my chronic pain (TMJ, lower back pain, sciatica, tennis elbow, golfer's elbow, etc) went away. The health benefits of early retirement are priceless! The time for working on a side-hustle before or after work is now. You never know what might become of it.
It'll feel weird giving up so much money at first. Golden handcuffs are incredibly tough to break. But I bet the value of your new found freedomwill far surpass any money you'll forsake.
Always remember that money is simply a tool for happiness. If you aren't happy then you must make a change. Either save more, change careers, or take some calculated risks. You don't want to look back at life with regret.
Wealth Building Recommendation
Instead of scraping by on $500,000 a year, why not live life to the fullest? To do so, sign up forEmpower, the web's best wealth management tool. It will help you get a better handle on your finances. You can use Empowerto track your net worth manage your cash flow. My favorite activity is x-raying my investment portfolios for excessive fees.
After you link all your accounts, run theRetirement Planner. It pulls your real data to give you as pure an estimation of your financial future as possible. Your goal should be to get to a 90% probability of achieving your goal.
There's no rewind button in life. Make the most of things today so you can enjoy life tomorrow. Scraping by sucks.
Build Wealth Through Real Estate
If you want to get out of the rat race sooner, you've got to build passive income. Real estate is a core asset class that has proven to build long-term wealth for Americans. Real estate is a tangible asset that provides utility and a steady stream of income if you own rental properties.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
Take a look at my two favorite real estate crowdfunding platforms.
Fundrise: A way for all investors to diversify into real estate through private funds with just $10. Fundrise has been around since 2012 and manages over $3.3 billion for 500,000+ investors.
The real estate platform invests primarily in residential and industrial properties in the Sunbelt, where valuations are cheaper and yields are higher. The spreading out of America is a long-term demographic trend. For most people, investing in a diversified fund is the way to go.
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 also have higher growth potential due to job growth and demographic trends.
If you are a real estate enthusiast with more time, you can build your own diversified real estate portfolio with CrowdStreet.However, before investing in each deal, make sure to do extensive due diligence on each sponsor. Understanding each sponsor's track record and experience is vital.
Both platforms are free to sign up and explore.
I've personally invested $954,000 in real estate crowdfunding across 18 projects. My goal is to diversify, earn 100% passive income, and take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$380,000.
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