A large income isn’t the only determining factor in the ability to achieve financial independence. The claim that it isn’t possible to achieve financial independence because of a lack of income certainly could be true, but this isn’t usually the case. While it’s true that making more money and saving more could allow one to achieve this state faster, that doesn’t mean that it is impossible to achieve at all. It is even possible to achieve financial independence faster than someone who makes more and saves less.
Take Home Pay
In this example we’ll take a look at the differences between Jack and Jill’s gross and net income, ignoring any potential state income tax and only focusing on the federal. Jack, who makes $100,000 before tax (gross) will end up with roughly $81,710.50 after paying federal income tax (net). Jill, who makes $50,000 before tax (gross) will end up with roughly $43,060.50 after paying federal income tax (net). So even though there is a $50,000 difference in gross income between the two, the net income is a difference of $38,650. Granted, this is still a significant amount of money, it does level the playing field a bit. What makes an even larger difference is how they decide to spend or save this money.
Marginal Tax Bracket
It’s important to understand how to arrive at the $81,710.50 and $43,060.50 net income numbers. There is a common misconception when it comes to tax brackets. It is often thought that if one were to earn just $1.00 above their current tax bracket that their entire income will be taxed at the new higher tax rate. This isn’t the case. Just the amount earned into the next bracket will be taxed at the increased rate. For example, Person A is a single filer and made $38,701 this year. The top of the 12% tax bracket is $38,700. They will be taxed $4,453.50 for the $38,700 and then they will pay 22% on anything above $38,700 up to $82,500. So they will pay 22% on the $1.00 amounting to $0.22 for a total of $4453.72.
Be More Like Jill
If Jack, who nets $81,710.50 per year, saves just 10% of his income he would be saving $8,171.05 per year. If he invested this money for 10 years and earned a 6% return this would grow to $128,796.10. Not bad! If Jill, who nets $43,060.50 per year, saves 50% of her income she would be saving $21,530.25 per year. If she invested this money for 10 years and earned the same 6% return her money would grow to $339,370.36. This is 163% more than Jack would have after 10 years! That’s pretty impressive.
I know a lot of people think saving 50% of their income isn’t possible (it absolutely is), but here’s another less dramatic example. If Jill saved half of that, just 25% of her income, she would be saving $10,765.13 per year. After 10 years at 6% that would grow to $169,685.26. This is still almost 32% more than Jack would have after 10 years.
What Are Your Goals
As you can see it’s not necessarily how much money you make, rather what you save. Cutting expenses, managing money and saving more in general can increase the time taken to reach financial independence. Personal goals will dictate how much can be cut and what must be budgeted for. The real question is what brings you value? Do you have any daily habits that are able to be cut? Maybe buying fast food type lunch everyday, morning coffee, lottery tickets, etc. Are these things truly adding happiness and value to your life?
Take a hard look at where you’re spending money and evaluate how much value your purchases are bringing you. Spend money on the things that truly make you happy. To me, financial independence is the best way to spend my money. It may take 10, 15 or even 20 years to achieve, but in the end I will have purchased the most powerful asset, time. Time to do the things that do bring value and happiness. Like spending time with family or quitting your job and pursuing your passions, even if it doesn’t pay well or even at all.
