Here is some sobering news; when you add up the taxes you pay to the Feds, payroll, state tax etc. (not even including property, sales, gas, and ad valorem tax) – you’re probably paying more than 30 percent of your income to some form of government. Today we are following up on that bombshell. And no, we don’t advocate moving to Canada or Europe – unless you want to pay even more taxes. What you can do, though, is educate yourself and adopt a TSL- driven budget. Remember the acronym, TSL. It’s the term we’ve coined for Taxes, Savings and Life – the three big buckets where most of our dollars go.
If you follow the TSL guidelines, budgeting will be a whole lot easier.
Taxes: 40 - 50%
Pro golfer Phil Michelson got into hot water when he complained that 62 percent of what he earns goes towards taxes now. Few people feel sorry for a guy who makes close to $50 million a year. However, his complaints weren’t that far off the mark, even though CNBC reported his estimate was a little high. Consider the new federal tax bracket that is nearly 40% on families that have income north of $450,000 and California’s 13 percent income tax, and you almost start to feel sorry for Phil. Almost.
Taxes take a huge bite out of all our paychecks. That's why we suggest you budget 40 percent of your income for taxes or closer to 50 percent for really high-income households, and you'll have a good sense of what's left over for Savings and Life.
For many years, Vanguard recommended saving between 8 to 12% of your gross income to guarantee a happy retirement. Recently, they upped that guideline to 12-15%. That’s thanks to lower return expectations in the future. We advise clients to try to save 20% of their gross income. That’s a significant number, but take into consideration the many “tax advantaged” ways to save (401k, SEP IRA, etc.) and you can get there a lot faster than you might think. In fact, you may be able to retire a lot sooner than you think. If 20 percent seems unrealistic right now, try starting smaller and work your way up to it.
Life – 30-40%
Now we're at the truly discretionary spending. We saved the best for last. The remaining 30 percent (40% if your tax bite is lower) of your income goes here. Spending just 30 to 40 percent of your income during your working years on living (food, shelter, transportation, insurance, kid-related costs, entertainment) will allow you to maintain your lifestyle once you retire. For Phil Mickelson, by the way, that means limiting his Life spending to about $15 million a year.
Our TSL formula (Taxes:40-50, Savings: 20, Life: 30-40) may seem harsh at first, but whoever said getting to Easy Street (and a happy retirement) was going to be easy?
Editor's Note: This article was originally posted on November 6, 2013. It has been updated as of January 13, 2016, to reflect the latest information.