Middle Class life on $400,000 annual income?

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October 11, 2020
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The $400,000 number seems to have garnered a lot of interest since recent the vice-presidential debate between the democratic nominee Kamila Harris (KH) and the republican nominee, Mike Pence (MP).

During the debate, KH said that Biden would not raise taxes on anyone making under $400,000 a year, which follows from the statement made by Biden back in May in an interview on CNBC. A logical conclusion to be drawn on this threshold, $400,000 and more per annum counts as rich in the United States.

Piggy-bagging on the news of the day, Financial Samurai, a popular personal finance blogger, put out an article testing out the claim whether $400,000 per annum income does indeed qualify for a rich life-style or rather a middle-class income for families living in high cost of living (HCOL) regions of the country

He starts out by defining what one would generally consider a middle class life-style and then lays out annual budget for a family of 4 living in one of th HCOL areas such as SF, NYC, Boston, LA, San Diego, Seattle, DC, Miami, Honolulu.

What piqued my interest was the fact that AVI family is a family of 4 living in the suburbs of Seattle, generally considered to be HCOL region of the country!  However, AVI family annual living expense for a middle class life-style (in conformity with the definition provided by Financial Samurai) is nowhere close to that put out by Financial Samurai in the stated article.

I therefore decided to do an apples-to-apples comparison for annual cost of living for AVI family to of the Financial Samurai family of 4. Before I outline the cash outflow comparison, lets go over the income side of the equation for a family of 4 making $400,000 gross income per year.

As outlined by Financial Samurai, the $400,000 figure represents combined salary for a working couple living in the state of California. The deductions applied on the gross income are: 31 % effective tax, (federal and state and FICA) and 401K contributions, amounting to $19,500 per adult in the family. Net income after taking into account these outlays, and compensating for the non-cash standard deduction and $4K child credit, for the family living in the state of California, $260,530.  For a couple living in Washington, an effective tax rate of 25 % would be considered reasonable, a gross income of $400,000 would generate a net income of ~$300,000 per annum for a family of 4 living in the state of WA.

That said, lets dig into the comparison on expenses. Highlighted in blue are line items where the differential between Financial Samurai expense and AVI family expense is >=$500. These differences are large enough to warrant a detailed discussion.

MonthlyExpense_2020

  • Daycare: This is a big one! AVI family is a two-person working household as well. However, Mrs AVI works from home, running a daycare service (more information on her daycare service can be found at https://www.tinybearsdaycare.com/). As such the cost of daycare for the eldest of AVI child is $0.  That said, the rates for a full-day daycare service in our neighborhood vary anywhere from $1250 to $1500 (spanning the spectrum of home-based-daycare to a private Montessori). Paying $3100 for a daycare service certainly sounds a lot!
  • Preschool/kid expense: I bucketed kid expenses (payment for various extracuricular activities such as art class etc..) with preschool cost simply because the second of AVI child is now in kindergarten attending a local public school and pre-school cost therefore is $0. This one is again a biggi in terms of differential for AVI family relative to those of Financial Samurai. Daycare + Preschool cost >$5000 or (>$60,000 per annum) can only be justified if both parents in a 2-income family are high-double digit earners!
  • 529 savings: This cannot be considered an expense in the traditional sense of the word. Putting aside $1500 in a tax-exempt account for the money to grow and be available for kids-education needs down the line is great. Some time back I noted why I do not buy into 529 savings plan, instead, AVI family puts aside $1000 per month ear-marked for kids education. In 15 years, these accounts would grow to $300,000 (not witstanding any capital gains), which we believe are sufficient to cover the 4 year-college expense for both kids going to a decent public school in the state. I would consider a privilage for a family to afford a private 4-year college education for both of their children and not something that a typical middle-class family can afford.
  • Food for Four: While we typically spend less than $1500 per month on groceries and other related items, I am accounting for the occasional eating out as part of this expense. I cannot fathom how a family of 4 with two very yound kids can spend $2000 just on food per month!
  • Mortgage: This is by far the biggest differential in terms of where the difference lie in terms of a long-term fixed-expense for the two families! The expense is clearly a life-style choice of whether one prefers to living in the HCOL city or in the suburs of a HCOL city. As Financial Samurai notes, it is not at all an exageration to pay upwards of $2 Million for a decent sized (~2000 sq.ft single family house).  At 3 % interest on a $2 Million house (after 20 % down payment), one is paying upwards of $6000 per month for mortgage. AVI family has made a concious choice of living in the suburbs of Seattle, where a dollar invested in housing can go much farther, see for example, a recently sold house in our neighborhood. A 2420 sq.ft single-family house sold for $800,000. At 3 % interest after 20 % down payment, the mortgage for such a property would be ~2700 per month.  For AVI family, the monthly mortgage of $5000 includes additional principal payment on the mortgage. The rationale being, this would be the amount that we would have paid monthly for a reasonably sized house purchased in proper city.
  • Family Care: While not a typical expense for an average middle-class family, for AVI family this is a personal expense that Mr AVI does to contribute to afford a comfortable life style for his parents in their home country!

Synopsis

Financial Samurai talks of cash flow of $4 per month, which may seem jarring but thats the point! He has laid out a viable expense summary for a family of 4 living in a HCOL neighborhood where house prices are through the roof and childcare eats into chuck of a dual family income! The differential in AVI family monthly expense pretty much comes from these three line items!

Another point worth noting, Financial Samurai takes care of  the business of saving for the future! His budget includes max contribution to 401 K plan per month as well as a robust monthly investment into child(ren) 529 plan!

On the face it may look like a cash flow of $4 per month, may leave no room for emergency expenses, but that is not the case at all! There is enough slack in Financial Samurai budget to reduce the monthly expenses significantly should there be an immediate need for cash! A few areas to trim for the month if so needed are: (a) Reduce monthly contributions to 529 plan! (b) Postpone/delay contribution to 401K (c) Cut down budget set aside for travel/vacation (d) Cut down on clother purchase for the month (e) Cut down on charity contributions for the month (f) Cut down on food consumption,$2000 per month does seem a bit too much to me.

Another point worth noting, child care and day care expenses are transient, should one decide to leverage the public school system which provides K12 education on tax payers dime!

My conclusion, even in a HCOL neighborhood like SF and even considering a life style choice of living within city limits, paying upwards of $2 Million for a house, $400,000 house-hold income should afford a family of 4 maintain a very comfortable lifestyle! Rich may be not, comfortably middle-class, most certainly!

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