Monday, April 16, 2007

Think Dual Incomes is a Great Thing? Not Always

The prospects of having two incomes to support household expenses sounds great. What's not to love? Double the money to pay bills, send your kid to college or enjoy life. Well that pesky "marriage tax" makes the calculation a little more difficult. True, individually two incomes are great, but in married couples are subject to different tax scales. There is a point of diminishing returns as your combined income gets higher and higher.

Take this hypothetical:
John makes $75,000 per year. Jane (his new wife) makes $50,000. Combined they bring in $125,000 yearly. If both work full-time childcare expenses will be $500 per month before and after school. Jane will also spend $1,000 a year to commute to and from work. Let's also say the local tax rate is 6% and they don't have a flexible spending account to sock pretax money for the additional childcare expenses.

Individually John would be in the 25% tax bracket approaching the 28%. Jane would be in the 25% tax bracket. While they individually hit the 28% tax bracket at $77,100, as a married couple they don't hit this bracket until $128,500. So, for income tax there is no real difference assuming that they don't get salary increases to move them into the 28% bracket.

However, the real problem is they will lose out in a lot of other ways. They will be taxed more for social security and medicare (jumping to 7.65% up to $97,000 then 1.45% thereafter. The child tax breaks begin phasing out at $110,000, they will also be unable to claim the Hope Education credit. The effective tax rate is a whole lot more than what the charts show.

So back to the fact scenario above. Assuming the very broad facts laid out above in my hypothetical the actual take home from Jane's $50,000 salary will be around
$27,425 or to put it a different way she nets 54.85% after costs and taxes. This is obviously a very rough estimate and there are lots of variables, but it's helpful to think about some of the other factors aside from just the salary figure. Try the calculator SmartMoney has created to simplify these factors and read about other potential problems that might come up.

Note: I'm not implying that the $20,000+ take home is a small sum, just that there are diminishing returns for high income couples and there are more variables to take into account. The $27k would most definitely be worth it for me. I also acknowledge that there are a lot of soft factors not in the equation. Lots of families decide that soft factors like spending more time with their spouse or raising children should trump extra income. That is a great decision for many people and I don't want to discount that - however, it would take an economist to figure out the opportunity cost (which I don't pretend to be) so it has been left out of my analysis. I would guess that if it was added in it would make a spouse staying home more attractive to some and less to others.


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