He is richest who is content with the least, for content is the wealth of nature. — Socrates

Are you on a financial treadmill? I talked to a friend recently, and the conversation made me think about why most Americans depend on social security for their retirement. Social security income represents about 41% of income of elderly. And, 15% of our seniors depend entirely on the social security income.

Friend: I accepted a new position as a director of IT.

me: Congratulations. Where is your new job?

Friend: Chicago. My salary has gone up almost 40%. I will be making over $250K.

Me: Outstanding. You deserve it for your acumen and hard work. What about your house?

Friend: I’m going to sell and take loss as it won’t be feasible for me to manage it remotely.

Me: Have you found an apartment in Chicago yet?

Friend: Well, I found an amazing deal. I am buying over a million dollar house for 900K.

This friend of mine lives in a decent four bedroom house worth about $400K in Atlanta. He is an extremely talented guy. So, I know that he will climb up the corporate ladder, but he certainly is aboard financial treadmill.

If you keep increasing your standard of living as you earn more then financially your are at a standstill. Worse yet,  Uncle Sam loves high earners. You will get taxed at 39.6% marginal rate once you make over 250K.

Most of us dwell more on wealth in terms of realized income. Ironically, most wealthy pay less taxes as they rely on investment income. For most part, long-term capital gain on investment income gets taxed at 15%. Also, investment income is not subject to payroll taxes( 6.2% for Social Security and 1.45% for Medicare). On the contrary, If you add payroll taxes, state income tax, property tax and sales tax then my friend may end up paying over 50% just in taxes from his realized income.

Law of Deferred Gratification

The surefire way to get off the financial treadmill is to keep growing income while maintaining same level of lifestyle. Every extra dollar earned should be invested into a tax deferred asset.

With all the pessimism and worst of economic woes, all of us are making more than we were fifteen years ago.  The only problem that hinders our journey to secure retirement is the fact that — unless we learn to live life of simplicity — increased demand posed by our lifestyle sucks every dollar that we’ve added to our income over the years.

All families struggling to get by on $100,000 a year can look down the street to see a family — somehow — manages to get by on $50,000 a year. Heck, the same family struggling to get by on $100,000 a year somehow survived and thrived once on $50,000 a year.

The point is that you can save money if you can learn to live with simplicity all the while increasing your income to secure your retirement.

The goal is to squirrel away every extra dollar earned into an investment income bucket.

Instead of buying a bigger house and expensive stuff to elevate his lifestyle, if my friend maintains his lifestyle at the previous salary he earned, he can invest extra 40K in tax deferred investments — real estate, tax-exempt municipal bonds and dividend reinvestment.

If we assume that his portfolio grows at modest 6% then within 15 years he can amass over $1 million in assets.

At that point, you can work part-time or retire with income from $1 million. How? Most of us have two major debts — mortgage debt and car loans. If you kept your lifestyle in check, you would have paid off your mortgage in these 15 years all the while your retirement portfolio grew to a cool $1 million. You can easily live off $60,000 from your retirement nest egg with no debt. If you are passionate about golf or touring the world around with your leisure time, you can work part-time to earn 20-30K extra. Keep in mind that once you reach over social security retirement age, you will get a nice check from Uncle Sam to fund your fun activities like golf or cruise to Bahamas.

A Simple Plan to Secure Retirement

Open two savings or checking accounts. One to pay your self first. And another to support your lifestyle.

Here’s the scoop — If you squirrel away every extra penny you make as you grow your income — assuming that you are getting paid more with your experience and skills — you will soon not only be maximizing your 401(k) contribution($16,500 for the current year and $5000 for IRA), but also adding more money to your other tax deferred assets.  The secret key is to assume as if that money never existed, ever to support your lifestyle!

What if you never climbed up the corporate ladder?

If you are one of those average Joe who lacks skills to climb up the corporate ladder then you may not see a sudden income spike like my friend did. You can still amass similar nest egg using the sample principle of living way below your means. The only difference is that you may have to wear your frugal hat religiously than those who make much more than you do.

Most of us start earning money in our 20’s and peak during our 50’s. Save and invest percentage equals to the age group your are in every year. In other words, if you are in 20’s start saving 20% of your salary every year; keep gradually saving 30% once you enter in that age group. You will have to save 50% once you get in your 50’s, but if you’ve made right financial decisions thus far then you should be on the lower spectrum of the debt curve in your 50’s.

So, if you are one of those unlucky average wage earners who never made more than your measly 3% raise every year after getting your first job with 50K salary, you will still have over $1 million as you will be making close to or over six figure in your 50’s.

The gist of this article is to keep same lifestyle all the while increasing your salary to a point where your investment income starts making same money per year or more compare to your earned income. It takes discipline and persistence, but it’s well worth it in the long run.

Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.

— Charles Dickens, David Copperfield, 1849, English novelist (1812 – 1870)

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