A few posts back, we learned how lifestyle inflation can be toxic. In case you’re wondering, there IS a time and place to inflate your lifestyle. However, you can’t just do it whenever you want. You have to EARN it. Here’s how it works.
The Basics
If your goal is financial independence, I recommend that you live on half your income and save the rest.
This means that if you’re making around $50,000 per year, you allocate $25,000 to saving or paying off debt. After a rough estimate of $5,000 in taxes, that leaves you $20,000 to spend on living expenses, otherwise known as your “lifestyle”.
The Effect of Higher Incomes
If you have a higher income, such as $100,000 per year, your savings goal and taxes increase, but so does your allowable yearly spending. Therefore, this is one way to earn an inflated lifestyle.
The chart below shows goal savings, estimate taxes, and allowable yearly spending for various income levels. The estimated taxes are very rough estimates, based upon a married filling jointly couple maxing out their 401k’s. Your taxes may vary significantly from these numbers based upon your individual circumstances. For example, Justin at Root of Good was able to pay close to $0 in taxes even with a household income of $150,000.
Notice that even at very high incomes, due to the high savings goals and much higher taxes, yearly allowable spending (“lifestyle”) does not actually increase in direct proportion to your income. Also note that if you earn a very high income but manage to spend less than the yearly allowable spending (i.e. you save >50% of your income), then you will reach financial independence that much sooner.
What Happens When You Reach Financial Independence?
If you carry on saving 50% of your income for approximately 17 years, you will have saved around 33x your yearly spending. At that point, using the 3% rule, you will be financially independent.
For example, if your household income is $100,000 per year, and you save $50,000 per year for 17 years (while living on $40,000 per year, as above), you will have around $1.4 million (assuming a 5% rate of return). $1.4 million is a little over 33x your yearly spending of $40,000 per year. Congratulations!
Earning the Right to Inflate Your Lifestyle
At financial independence, you have a few options (actually, many options). If you are comfortable spending $40,000 per year for the rest of your life (adjusted for inflation), then you no longer have to work. However, if you enjoy working and want to continue, then your nest egg will continue to grow. As your nest egg grows, you will be earning the right to spend more and more per year.
For example, if you grow your nest egg from $1.4 million to $2 million, you have earned the right to inflate your lifestyle to $60,000 per year. If you can grow it to $5 million, you have earned the right to inflate your lifestyle to $150,000 per year.
Summary
Lifestyle inflation becomes a problem when you haven’t actually earned the right to inflate your lifestyle. However, if you find ways to increase your income (while still saving 50%), OR you have already reached financial independence and your nest egg continues to grow, then feel free to increase your lifestyle accordingly. In that case, you’ve earned it.
I used to think Dave Ramsey recommended a daring goal – save 15% for retirement. Wow. I had learned 10% from the Richest Man in Babylon. Then there is WCI and others who pushed doctors to save more like 20% of gross. Then PoF threw down a challenge for 50% savings based on net. That may be closer to a third of gross? I think you recommend 50% of gross. Where does this end? I’m waiting for someone to recommend 75%. Actually, that isn’t a bad idea. It could be doable if you are a specialist and live as an average citizen.
I never had a fixed percentage to save. I just set my own “salary” and set it artificially low. The amount I save varies on all kinds of factors that vary during the year and year to year. However you save or spend, I agree lifestyle inflation is a huge factor.
Sent by email:
“I used to think Dave Ramsey recommended a daring goal – save 15% for retirement. Wow. I had learned 10% from the Richest Man in Babylon. Then there is WCI and others who pushed doctors to save more like 20% of gross. Then PoF threw down a challenge for 50% savings based on net. That may be closer to a third of gross? I think you recommend 50% of gross. Where does this end? I’m waiting for someone to recommend 75%. Actually, that isn’t a bad idea. It could be doable if you are a specialist and live as an average citizen.
I never had a fixed percentage to save. I just set my own “salary” and set it artificially low. The amount I save varies on all kinds of factors that vary during the year and year to year. However you save or spend, I agree lifestyle inflation is a huge factor.”
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I agree that 50% of gross is an aggressive savings goal. It might not be for everyone, but it’s what I recommend if you really want your freedom within 15 years. If you prefer to live more comfortably early on and are satisfied with earning your freedom in 30 years of so, then 20% is just fine. The great thing about this is we all have a choice.
It’s easy to equate lifestyle inflation with spending. I’m certainly guilty of having done that, but I’ve realized that lifestyle and spending aren’t quite the same thing.
Working part time, I feel I’ve inflated my lifestyle immeasurably without spending an extra dime. Having more time to do all that I want to do (or at least some of it) feel like a huge lifestyle upgrade. Of course, it wasn’t until I had earned FI that I felt I had earned the right to live this way, so I suppose it’s all intertwined.
Cheers!
-PoF
That’s a great point. If by lifestyle you mean quality of life, you can significantly increase your quality of life without spending any additional money. For example, you can work less, find a more rewarding job, cook more nourishing meals, or live in a place with more recreational opportunities.