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:
- You’re 40 years old
- You’re married
- You have two kids (10 and 6)
- You don’t live in one of the crazy expensive cities like NYC or SF. For state tax purposes, you’re a Hoosier (you live in Indiana).
- You also value the presence of B felonies
- Your annual health insurance cost is $4,565 ($380.42/month), based on the average cost for a family of four in the US. These premiums are not taxable, in our example.
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
- $5,301.69 take-home pay
- $1,500/month 401k contribution
- Projected 401k balance from age 40-67 $1.7 million
Broken down, here’s how you’d spend your money:
- $1,325 for Rent or Mortgage (includes principal, interest, property taxes, and taxes)
- $795 for Transportation (includes car payment(s), fuel, insurance, maintenance
- $636 for Groceries and Dining-out
- $530 for Emergency Fund of Mid-Term Savings (includes college savings)
- $530 for Utilities (includes EVERYTHING)
- $265 for Community/Charity
- $265 for Clothing
- $265 for Entertainment
- $265 for Medical
- $265 for Holidays and Gifts
- $159 for Miscellaneous.
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
- $6,267.69 take-home pay
- $500/month 401k contribution
- Projected 401k balance from age 40-67 $570,690
Broken down, here’s how you’d spend your money:
- $1,566 for Rent or Mortgage (includes principal, interest, property taxes, and taxes)
- $940 for Transportation (includes car payment(s), fuel, insurance, maintenance
- $752 for Groceries and Dining-out
- $626 for Emergency Fund of Mid-Term Savings (includes college savings)
- $626 for Utilities (includes EVERYTHING)
- $313 for Community/Charity
- $313 for Clothing
- $313 for Entertainment
- $313 for Medical
- $313 for Holidays and Gifts
- $188 for Miscellaneous.
Worth it? Nah.
No contribution to your 401k
- $6,750 take-home pay
- $0/month 401k contribution
- Projected 401k balance from age 40-67 Goose Egg
Broken down, here’s how you’d spend your money:
- $1,687 for Rent or Mortgage (includes principal, interest, property taxes, and taxes)
- $1,012 for Transportation (includes car payment(s), fuel, insurance, maintenance
- $810 for Groceries and Dining-out
- $675 for Emergency Fund of Mid-Term Savings (includes college savings)
- $675 for Utilities (includes EVERYTHING)
- $337 for Community/Charity
- $337 for Clothing
- $337 for Entertainment
- $337 for Medical
- $337 for Holidays and Gifts
- $168 for Miscellaneous.
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.
- Begin to cut expenses, and redirect money toward retirement.
- Direct all future pay increases directly to retirement.
- Both.
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.
Peter Dunn a.k.a. Pete the Planner® is an award-winning financial mind and a former comedian. He’s a USA TODAY columnist, author of ten books, and is the host of the popular radio show and podcast, The Pete the Planner Show. Pete is considered one of the foremost experts on financial wellness in the world, but he’s just as likely to talk your ear off about bass fishing.
Hey Pete, thanks for the article, really interesting.
So how do funds for travel/vacations and christmas/birthday/etc presents play into this budget?
Thanks, Ben. Holidays and gifts are IN the ideal household budget. Obviously since we break it down over a monthly basis, you will need to redistribute the monthly holidays and gifts budget over the year appropriately.
Vacations are a sticky situation. So much so, that I’m dedicating an entire TV/Radio show to them in the coming weeks. A vacation, although great, is not necessary. I’m sure I’ll lose people there. For any expense that’s not on the list, simply carve-out spending of other categories.
Great comparisons! Food for thought…
Thanks, Aimee. Many more to come.
I like the budget breakdown. But where does childcare fit into the budget? With two kids in before/after school programs, it adds up fast.
Hey Jessica
You’re correct. Even at 10 and 6 years old, there’s some daycare costs to consider. There are two primary options to fund that. You could decrease your retirement plan contribution, which then wastes time. Or you could reduce your spending in other categories. You could spend less on housing, travel, entertainment, et cetera.
Hi Pete
Overall I like the framework. I noticed that you said to assume that you have two kids but I don’t see anywhere in the budget for childcare (work related). Up in the “032” we pay about $1500 a month for two kids to be in daycare.
Hey Brian
I’m right there with you. We used to pay about $1,300/month in day care costs. A couple of things to consider – in my example, the kids were school-age. Thus eliminating daycare costs. But more importantly, there’s a lot of specific expenses which aren’t on the ideal household, such as child care, travel sports, et cetera. You gotta adjust the pie. You must carve-out other expenses from the categories that exist, all the while keeping your eye toward the future. It’s difficult stuff.
Interesting article, waiting for the other income brackets. Questioning the averages on medical insurance. I understand your source, would be curious if your readers agreed. Family of 5, paying $7662 annually: $4500 HSA, $3162 premiums. HSA amount covers deductible.
Hey Chris. Over the next few week I’ll sprinkle the other incomes out. I’m thinking 40k, 250k, 60k, 80k. If you want to see anything else, let me know.
As far as healthcare. Excellent point. For instance, I have a family of four, and with max HSA contribution, we pay just under $18,000 year. Of course, I pay for all of our healthcare, because I’m the employer. The major assumption I made on this post was that an employer subsidized the cost.
The harsh reality is that just like my other examples of “adjust the pie”, that’s what you would need to do here too. Debt? Adjust the pie. Big healthcare? Adjust the pie. Child care? Adjust the pie. The reality of retirement projections don’t change, but the day to day decisions get harder.
are you assuming you will not have your mortgage payed off prior to age 67?
I always think paying off the mortgage prior to retirement is the correct strategy.
Thanks, Pete. The scenarios here are endless, but I’d like to see one or two tied to an empty-nester or retiree. Thanks for the great info.
I like how you give people a framework for a budget, that’s very rare. Most people have no idea what they should spend on each category. Personally, though, I always put eating out under entertainment rather than groceries. It really is America’s favorite former of entertainment and usually has very little to do with food or nutrition.
On a sidenote: your retirement calculator says that we will have less money in 10 years than we have now. Seems to be a bug.
Agree there is a bug in that calculator. I already have a million but I am in my 50s and want to see how I am doing. You can’t go over a million on that calculator. Needs a fix!
Hi Colleen, thanks for the heads up! It’s been fixed, go ahead and try it again!
Are other forms of insurance (not house, car, or medical) under miscellaneous? We spend $21/month for umbrella, $263/month for long term care, $160/month for term life, and another $169/month for life insurance through work! I know these numbers would be less at age 40 (we are 52), but, still, shouldn’t your ideal budget include a category for life insurance? After all, “you should buy life insurance” is one of your basic beliefs about money.
Hi Pete,
I’m on my way to figuring out my budget, with a lot of focus on savings and retirement contribution. My dilemma, though, is that I do not have an employer-sponsored plan through my job right now so there is no matching option. Outside of contribution as much as I can to my retirement plan, is there anything you suggest to help? It’s not an ideal situation, I know…
Great question! I have a much bigger post coming up on this in the next couple weeks, but the very short answer is other tax-sensitive investments. The challenge is the tax status of each investment account. You won’t be able to defer taxes, which is one of the primary appeals of a tax qualified plan. STAY TUNED!
Pete, where do 529 contributions fall? Three kids – I’d like to think part of savings, although a different avenue. However, I feel a pie answer brewing…
This is great Pete but where we live, 1325 a month will only rent you a very small studio or 1 bdrm apt in a bad area. We have 2 kids at home. this will definitely need to come from other areas of the budget.
My husband and I are currently making $118K gross. We purchased a simple home and paid it off as fast as we could. Currently, we are EACH maxing out our tax deferred savings ($36K per year) and EACH maxing out ROTH IRA contributions ($11,000 per year) for a total of $47K going toward retirement savings. We live modestly, but still enjoy vacations and all the creature comforts. I find it really hard to believe that saving would be a struggle for most people on this salary, unless expenses are extraordinary.
We make $120k a year there about. We currently invest 6% in retirement. We pay $1900 a month mortgage for 3 bed house. Daycare is $2200 a month for one toddler and aftercare. We pay $800 a month in food and eating out w diapers and wipes. It is hard for us Not to go over budget. We also have to pay $200 a month for OT for my son have $2500 health deductible we almost always have to pay. We have no car payments but pay about $600 in gas and insurance no idea how the $700 could realistically work including tolls and repairs. No idea how you could say you can live off this and pay off mortgage and enjoy vacations! I mean there is simply no room and we are only invest 6% maybe 7 % to retirement( husband might have increased to 7). I mean I want my kids to do extracurricular activities so we have that. I do feel this is needed for their well being and to stay away from drugs. We have housekeeping service at $200 a month because I do have a bad shoulder due to car accident 3 years ago. We go out to eat maybe twice a week and for like pizza or chic fil a not fancy restaurants. We were making more at one point so went on some nice vacations also before we realized we weren’t saving enough for retirement. We have 3-6 month emergency Fun probably a little more but if something happened we would have a hard time coming up with that money again! I am awake at night worrying how we are possibly supposed to save enough on this salary despite making what I consider good money. Should we take savings and put to retirement? Going crazy here!
I love your advice and often quote you to friends and family. I’m one of those strange people who loves living on a spending plan/budget since (to me) it’s very freeing to know when I make a purchase that it’s “in the budget” and I have no guilt nor do I spend time wondering if it will come back to bite me.
I notice from the comments and your responses that you don’t view this sample plan as a be-all, end-all. You specifically address child care and vacation categories Since those are areas we have some control over, I understand needing to carve out the dollars from another category and why there were too many variations to address all of them.
The one area where I have a quibble with you is on home maintenance. In my opinion, it NEEDS to be in the mortgage category as people dismiss the major expense it is. I have tracked our spending to the penny for over 15 years and can tell you that general home maintenance has cost us 1.3% of our home’s value. That is only the smaller stuff (appliance repair and maintenance, fixing things that break, grass seed, fertilizer, etc.) When looking at major home maintenance costs such as roof and HVAC replacement, painting the outside of the house, that adds another .5 – .6%. When adding these two categories together, our experience says 2% of the home’s value annually is realistic. Assuming a $250,000 home, that’s an additional $5,000 per year or $417/month. I’ve seen people say they don’t spend this on maintenance, but it’s just like any other big-ticket item. A $10,000 HVAC replacement is something you know will happen at some point and not saving for it is just sticking your head in the sand.
Home maintenance/repair isn’t a negotiable item – it just comes with home ownership and most people ignore this when deciding what they can afford to purchase.
Excellent points. I wondered where folks were putting home maintenance. I have to acknowledge that when figuring in home maintenance, we are ‘over housed’. Having moved from a condo into a well maintained but older home, we underestimated what it would take to care for it. 🙁 It must be done, though, or otherwise we neglect our investment.
I agree! I track everything and maintenance on our 20 yo house is huge. I even calculated depreciation and estimated the probability of replacement/ total failure for all major house systems. It’s staggering. Then there’s the lightning strike that destroyed my trees, and now I include some landscape replacement. Maintenance is the number one reason I think we can’t afford our house in retirement.