Chapter 2 – Which Middle Class?

My last blog, published July 16th, was the first of a three-part series addressing the financial challenges faced by America’s middle class.  If you didn’t see Part 1, you might want to take a minute and catch up here.  That post focused on laying out the challenges, and addressed some of the public policy prescriptions that should be addressed to help the middle class survive.  I promised to circle back to the personal financial planning that I provide in this next installment, so here goes: 

social-justice-fist-filteredHarkening back to my student days, I have not one but two excuses for being a little late in tackling this assignment.  First, I’ve enjoyed a couple of week-long trips this summer.  More significantly, the assignment really turned out to be twice as much work as I’d expected.

Simply put, America has two very distinct middle classes.   Their circumstances are starkly different and, I fear, diverging at an alarming rate.  Let’s call them the Struggling Class and the Prospering Class.

The Struggling Class

The facts is that those at the bottom of the “middle class” are at great risk.  With great diligence, they may secure a reasonable financial existence, but any number of unforeseen hardships could push them into poverty in a heart beat. By standard economic definition, if you live in the Denver area here’s the bottom of the middle class as of June 2016[1]: (figures are Gross annual income)

  • 1 person household:  $25,200
  • 2 person household:  $35,500
  • 3 person household:  $43,700
  • 4 person household:   $50,300

Using my standard financial planning tools, I put together both a household budget and a long-term financial plan for a three-person household. In this case, I assumed a single parent, age 35, with two school age children and a  $43,700 in income.    In other words, she has a professional level salary, that likely required a bachelor’s degree.

To get a budget to balance for a family of three living on $3,642/mo was, frankly, a mind boggling exercise.  A few highlights:

  • There was simply no way that I could build childcare expenses into the equation. So grandma and grandpa better be willing to fill this need.
  • I did budget 3% of the parent’s salary to contribute to her employer sponsored retirement plan, and assumed a 3% employer match. Without this, she leaves “free money” on the table, and any hope of retirement in shambles.
  • Among the budget categories that I had to leave at zero were children’s activities, saving for college, recreation, vacations, and charitable contributions.
  • Health care, including medical, dental, and vision insurance and out of pocket expenses are only $200/month due to the extraordinarily good insurance coverage her employer provides, and everyone’s excellent health.

If this single parent and her family are truly lucky enough to muddle through without any serious financial setbacks for the next 15 to 20 years until the kids are on their own, and her wages keep pace with inflation, then perhaps things get a bit brighter.  That is, she’ll have some years between then and retirement when she can save a bit more aggressively and build her nest egg.

As with any financial plan for a 35 year old, there are many uncertainties in predicting their retirement outlook.  What we can say for certain for this family is that the short and mid term will necessarily be focused on managing month to month cash flow, and planning for the long term will play second fiddle.  We also know that there is precious little margin for error.  A illness, injury, job loss, car problem, or any number of things could very quickly make the picture much worse.

Let’s assume that our single parent remains single and is healthy enough to work to age 70.  If all goes well, here’s a picture of what her retirement income would provide:

Social Security stays intact, and will provide benefits based on today’s law and formulas.[2]  That is, she’ll receive $1,630/mo in today’s dollars at age 70.  Social Security will provide annual cost of living increases, but these increases are already rigged to not fully keep pace with inflation.

To her infinite credit, she was able to stick with contributing 3% throughout her working years to her retirement plan, and her employer fully matched her contribution.  She earns a respectable 6.5% average annual return throughout.  With 25 years of diligent savings, she amasses a substantial nest egg of $475,000!  Note, though, that this only amounts to about $165,000 in today’s dollars.

On the expense side, let’s assume that our retiree can live on a very limiting after-tax budget of $1,750/mo once she retires.  Here’s what that budget provides:

  • She was never able to buy a home, so we must continue to budget $700/mo for rent.
  • She isn’t poor enough for Medicaid, and Medicare doesn’t cover dental or vision expenses so I budgeted $300/mo for supplemental medical insurance and out of pocket expenses.
  • She’ll be distributing enough money from her IRA to owe about $145/mo in income taxes.
  • This leaves $605/mo for food, clothing, utilities, and everything else.
  • With this limited budget, she can no longer afford a car.
  • As tight as this budget is, perhaps living with one of her children becomes the only realistic scenario.

With all of these assumptions, how long will her money last?  The odds are, she’ll have enough money to last until age 93, or a bit beyond life expectancy.  More realistically, if she has some major health care expenses late in life, but lives only to her mid-eighties, she’ll die just about as the money runs out.  And that’s all under our optimistic scenario.

Ultimately, as a financial planner, there is only so much advice I can provide to this client:  I can help them budget wisely, to dogmatically contribute whatever their employer will match to a retirement plan, no matter what, and then they can to hope and pray that they are never beset by any unforeseen financial misfortune. Ever.  I also must have them abandon the hope of helping their children pay for college.

How on earth can I do this with a straight face and without sharing their rage at a system where they work throughout their adult life at what would seem to be a respectable salary and still face such long odds of success?

I do not have a satisfactory answer to this question.

The Prospering Class

The other end of what economists define as the middle class might as well be at the other end of the universe.  Again by standard definitions, the top end of middle class gross income in the Denver area as of June, 2016 is as follows:

  • 1 person household:  $75,500
  • 2 person household:  $106,800
  • 3 person household:  $131,000
  • 4 person household:   $151,100

I didn’t specifically put together a financial plan for someone with these circumstances.  But in fact I work with folks such as these all the time.  Suffice it to say that Denver families with these incomes can indeed have a comfortable standard of living and a secure financial future.  Do they always? No.  But if they do end up in financial difficulty, more often than not it’s because they spend way too much, and save too little; it’s not that they don’t earn enough.  These folks aren’t home free either.  A death or disability can throw them into a tailspin, (but they can also protect against these risks).  If they came out of school with too much debt, are trying to buy a home in our inflated market, or intend to send their kids to private college, they face challenges and trade-offs.  With good planning and judgment, they will indeed prosper.  One thing they could probably use is a good financial planner – please give them my number.

There is, of course, a broad distribution of incomes across our so-called middle class.  Somewhere along this spectrum the tide shifts from a fairly dismal to a far more optimistic outlook.  Why economists call all of these people “middle class” is beyond me.  Perhaps a closer look at what seems to be just semantics would help us to better focus on the challenges at hand.

As I noted in my earlier installment, part three of this series will tie this conversation about the middle class to issues of sustainability.  Stay tuned…

[1] Pew Research Center.  http://www.pewresearch.org/fact-tank/2016/05/11/are-you-in-the-american-middle-class/

[2] In reality, Social Security takes in only enough revenue to sustain paying about 70% of current benefit levels.  Reducing benefits to our hypothetical retiree by 30% would make her retirement much bleaker than outlined here.

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Ken Jacobs CFP®, AIF®, CLU and Renee Morgan are investment advisor representatives of First Affirmative Financial Network (“First Affirmative”). Ken and Renee own an entity called Sustainable World Financial Advisors (SWFA) which is not affiliated with First Affirmative nor is it a registered entity. SWFA does not offer investment services, those services are offered by First Affirmative which is a Registered Investment Advisor (SEC File #801-56587). SWFA is a “doing business as” (DBA) name for use in its operations and should not be considered a registered entity offering investment services. The credentials CFP® & AIF® listed above bear trademarks. FAFN-Logo-(1)
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