Income: More is less? Less is more?

[Sam]

Original article on Personal Finance Ratios by Charles J. Farrell:

http://www.fpanet.org/journal/articles/2006_Issues/jfp0106-art6.cfm

Table 1 in the above article says that a 50 years old should have the following ratios:

4.50 Saving/Income
0.75 Debt/Income
and 12% saving rate

I wonder who can more easily achieve those numbers.  A family with X income or one with 2X.  On the surface, it seems obvious that the more money you make, the more you can save.  But is it true in real life?

 

[Hydroman]

What I found more interesting is that the author was advocated that a 5% is historically a more realistic SWR, although acknowledging 4% is probably more appropriate "right now" with the high stock valuations.

 

[Sam]

What I found more interesting is that the author was advocated that a 5% is historically a more realistic SWR, although acknowledging 4% is probably more appropriate "right now" with the high stock valuations.

Actually I am in agreement with his 5%.  But that's another subject that has been discussed over many times on this board.

 

[Hydroman]

Well to answer your original question, it is true if you want it to be. It is an individual decision on whether to spend salary increases or save them. Right now I save close to 60% of my gross salary and I am making less then $100K with a wife and 2 teens (one who is in college.) And I will still be able to afford the 2 week trip to Italy in a couple months. It is all about personal priorities.

 

[LOL!]

I wonder who can more easily achieve those numbers.  A family with X income or one with 2X.  On the surface, it seems obvious that the more money you make, the more you can save.  But is it true in real life?

Yes, it is absolutely true.  Just because you make twice as much income does not mean that you have to spend twice as much on a house or twice as much on a car.  Indeed, often the 1X spend more money on a car when you add in all the loan payments, while the 2X may buy the same car for cash.

We are now making 2X what we were making 12 years ago when we bought our house.   We are not going to go out and buy another house with a concomitant doubling of mortgage, utilities, property taxes and insurance costs.  Nope, we are gonna sit tight and invest that extra money.

 

[Sam]

What about taxes? 2x normally translates into 3x or more taxes.

 

[astromeria]

I can tell you from personal experience that it is way, way harder to save any percentage you care to name on a low income than a high one. It's easier of course if you're single and have roommates than if you're married and have children. It's easier if you live "among your own" rather than among those who can afford more. Not to mention that--especially among those who earn less than average incomes--there often isn't usually a smooth trajectory from lower to higher income over the years. Often there's feast and famine, and savings during feasts can get depleted during famines.

Taxes is much less a factor than income (or even interest rates)--else how did we have rich people when top brackets were much higher than today?

 

[LOL!]

What about taxes?  2x normally translates into 3x or more taxes.

That's a big myth. 2X means more money that you can contribute to your 401(k) and Roth. Also the long term capital gains tax rate is 15% for even the wealthy. Qualified dividends are taxed at 15 as well. Unrealized capital gains are not taxed at all.

As a concrete example, my spouse got a raise last year and she will be 50 later this year. So her taxes actually went DOWN because she can contribute all the raise and more to her 401(k) plan.

 

[Alan]

That's a big myth.  2X means more money that you can contribute to your 401(k) and Roth.  Also the long term capital gains tax rate is 15% for even the wealthy.  Qualified dividends are taxed at 15 as well.  Unrealized capital gains are not taxed at all.

As a concrete example, my spouse got a raise last year and she will be 50 later this year.  So her taxes actually went DOWN because she can contribute all the raise and more to her 401(k) plan.

I agree but it got me wondering so I went back to my tax return of 1994 and compared it to last year - 2005.

In 1994 I had 3 dependants (wife and 2 children), a mortgage ($3,500 in interest), state income taxes of $2,200, property taxes of $500.  Gross salary was $81,250 before 401(k) etc.  other income of $3,400 giving a total of $84,650.  I paid taxes of $14,220 that year.

In 2005 I have only 1 dependent (wife), no mortgage, no state taxes, no property taxes. Gross salary was $187,700.  Other income of $17,300 giving a total of $205K.  I paid taxes of $34,800.

That is an increase in gross earnings of x 2.42.  Taxes increased by 2.44.  I know that taxes have come down since then but I have so few deductions these days I take the standard deduction.

So from a personal point of view, I also don't believe 2x income = 3x taxes.

 

[Sam]

Thank you all for your replies.  Here's why I brought the subject up for discussion:

I like the article a lot because of its universal nature - independent of family income.  Therefore I emailed it to a dozen people in my circle of friends/relatives/peers.  Most of them responded positively, thanked me for the article, and told me that they are on track or quite close to it. 

Surprisingly, one response was negative.  This person said that her family was several years behind, and thought that the ratios given are optimistic.  This family happens to be the one with the highest income, at least 2 times higher than the rest of the group.  Husband and wife are 49 and 50 yo.  Husband is an engineering director in a hi-tech company, wife is a doctor.