One of my favorite hip hop songs of all time is If I Ruled the World by Nas. I like how he lists all the things he'd do if he happened to rule the world. I agree with some of his promises like "Designer clothes, lacing your click up with diamond vogues." Who wouldn't want their friends looking fresh and rolling on jewel-encrusted wheels? I like it, Nas. I like it. But then he goes on to say he wants to eliminate B felonies. I have a liberal arts degree, not a criminal justice degree, so I'm not 100 percent confident as to what I'm about to say: but I have no problem with B felonies. So let's keep those.
Anywho. Today is the day I drop my jam, If I Ruled Your $120,000 Household Income. Don't worry, I'll be releasing remixes tackling other household income levels.
But today, I'm going to explain what the proper use of a $120,000 income looks like.
We need a set of assumptions here. Here they are:
The only place we can conceivably begin is with taxes. Your paycheck can either get crushed with taxes or less-than-crushed with taxes. I'm not going to pretend like we don't need roads, school, and other elements of both physical and social infrastructure. The point of this post isn't tax avoidance, although tax efficiency is certainly appealing.
Your gross (before tax) monthly income on a $120,000 household income is $10,000. What we need to figure out is how much of that we should bring home. You control that by the amount of money you choose to defer into a defined contribution plan (401k, etc). You can either contribute nothing to your retirement plan and net out $6,750.69 each month, you can max out your 401k and net $5,301.69, or anywhere in between by adjusting your contribution percentage.
Don't gloss over the decision here. Not to get all dramatic up in this mess, but it's a life or death decision. People typically don't view it that way, but it is. Choose incorrectly, and you will run out of money in about 40 years. Choose correctly, and you will never worry about money again. We never really think in these terms, do we? You and I are both just fighting the fires in front of us. It seems crazy to fight a fire which is 40 years away. But you should. You're an adult. You understand object permanence.
For some perspective, choosing the $5,301.69 net pay will result in a projected $1.7 million in your 401k at age 67 (based on 8 percent average rate of return, no raises, no match, and no contribution limit increases). Compare that to a $6,267.69 net pay, which would result in a retirement account balance of $570,690 at age 67. Can you survive retirement 27 years from now on $570,690? Sure, but it would be ugly. Factoring in inflation and a healthy withdrawal rate, your monthly income would be about $683, in today's dollars. The monthly retirement income for maxing out your retirement account now by choosing the $5,301.69 net pay would be approximately $2,050, in today's dollars.
I understand that you've likely set your lifestyle based on your current take-home pay, and unweaving your expenses seems about as possible has elegantly deconstructing a shredded wheat biscuit. But where I think a vast majority of people fail is when they're unwilling to accept the math I just mathed. Yeah, I used math as a verb. I'm that good.
How in the heck are you going to survive on $683/month + social security, coming off a $10,000/month income? You aren't.
"I can always crank up my savings later," you yodel. Fine. If you accept the $6,267.69 paycheck (5 percent contribution to 401k) now, then crank up to a 15 percent contribution five years from now, your balance at 67 would be $1.2 million. Yes, you just made a $500,000 mistake. People are so convinced that an opulent lifestyle is about wasting money, but it's not. When your lifestyle is too big, you're wasting time. In this example, wasting five years wasted $500,000. I know, it hurts.
Here's what we'll agree to do: I'll show you three different lifestyles based on three different take-home pays. I'll start with the max 401k contribution, then show you a five percent contribution, and then no contribution at all (yikes).
The next part of this exercise is subjective. But frankly, I like my subjective opinions quite a bit. They border on objective. Let's divvy up your net pay using Pete the Planner's Ideal Household Budget! That was shameless.
Download your own Ideal Budget here.
Max-out 401k
Broken down, here's how you'd spend your money:
If you live THIS financial life, you will never worry about money again. I can't promise you that, you know, because obviously. But this is a beautiful and flexible financial life. Don't have that high of transportation costs? Cool. Adjust the pie. Spend more on housing? Fine. Adjust the pie. Eat too much pie? Okay, man. Adjust the pie. It's not terribly hard.
Five percent contribution to your 401k
Broken down, here's how you'd spend your money:
Worth it? Nah.
No contribution to your 401k
Broken down, here's how you'd spend your money:
Whatever, man.
What to do now
I remember when I first looked at the nutritional info for my favorite meal at Steak N Shake. I was sick to my stomach. "But everything was going so well," I pleaded. The trust SUCKS sometimes. What are you going to do about it? Build a time machine, go back, and not read this post? I gotta be honest, that would be amazing.
You can fix this a few different ways.
Like running a marathon, this will be hard but gratifying. Or so says my wife. She's run several. Me? I like Steak N Shake.
I can help you with this. It's what I do. I will walk you through the process of fixing your future, right now. For $100 off, use coupon code: Nas.
****Special shoutout to Phil Schuman from IU MoneySmarts for the paycheck calculations. You the real MVP, Phil.
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