ARE YOU IN THE AMERICAN MIDDLE CLASS OR NOT?
By MARY LYNNE DAHL, CFP®
November 16, 2017
When surveyed, very few people respond that they feel “wealthy”, even if their incomes are 3 or 4 times the national average. People learning $200,000- $400,000 per year routinely say that they are not “wealthy”, so clearly, the definition of the word is an issue when counting who is and who is not part of the American middle class.
When we refer to our wealth, we are talking about our financial status. This includes our earned income from work, investments and property plus our retirement income from pensions, Social Security and other sources of retirement income. It also includes the value of all of our assets, such as our home, rental property, retirement plans, investment portfolio and other valuable things we own. This wealth may be a big number or a small number, but it is all wealth to some degree. So, even if you do not feel wealthy, you probably do have some wealth. Unless you own absolutely nothing and have absolutely no income, you have wealth of some amount. Compared to the rest of the world in particular, almost everyone in the US (and other western nations) is wealthy, in fact. But I digress here. The question isn’t how you compare to Zimbabwe or Pakistan. The question is how you compare to other Americans
Studies abound on this subject, so there is no lack of information. The problem is that it is confusing and not entirely consistent. Most studies, however, do fall into similar ranges of numbers when it comes to income and net worth, the primary determinants of wealth in America. The results do show that about half of Americans are middle class households, and of that 50% of households, but the middle class range of wealth has grown to a much wider range than it used to be. It has expanded to 3 levels of middle class, not just one, and reflects a growing layer of affluence on the higher income of the middle class.
Data from a study by Jordan Weismann of MoneyBox showed that although 76% of people in the US earn at least $250,000 for 1 year, only 2% will sustain that earning power for at least 10 years. Another study done by CNN Money Urban Institute Report says that 29.4% of Americans earned between $100,000 and $350,000 for a 3 person household in 2014. The averages of most studies done put the American middle class at 32% - 35% of the population, with the upper middle class at 28% - 30% and the lower middle class at 11% - 18%. Those at below poverty level are at 14% - 15% of the population and the super-rich are at 1% -2%. The poverty level is not an average of other studies; it is the official number of the US Census Bureau, with a family of 2 adults and 2 children living on $24,239 or less.
According the US Department of Health & Human Services, in the US lower 48 states, the federal poverty level is income of less than $12,060 for 1 person, $20,420 for a 3 person household and $28,780 for a household of 5 people. In Alaska, the amounts are income of less than $15,060 for a 1 person household, $25,520 for a 3 person household and $35,980 for a household of 5 people to qualify as poverty level. In Hawaii, incomes of less than $13,860 for 1 person, $23,480 for 3 and $33,100 for 5 person households will qualify as poverty level.
If you search the question online, you will generally find that being classified as middle class in the US means that an individual earns about $55,000 - $75,000 per year and has a net worth that is a percentage of annual income at certain ages, starting at about 10% of annual income in your 20’s, moving all the way up to about 10 times annual income in your late 60’s and then declining after age 70. Using the simplest of factors, that would mean you might start out with a net worth of about $6,000 in your twenties and end up with a net worth of about $750,000 in your late sixties and be considered middle income all of your life.
Clearly, there are some variables here that are interesting. As it turns out, there are 3 categories of middle class. They are lower middle class, middle class and upper middle class. Those people who fall into the upper middle class are also referred to as “mass affluent”. The mass affluent are not super rich, but they make a lot more money than the average American and they end up with a higher net worth at retirement than the average American. The middle class, then, has grown to a wider range of income and net worth, as a result. If we leave out the super-rich in our scale of wealth, the real question is not whether you are middle class or wealthy. The real question is where do you fit on the scale, from poverty to mass affluent?
Another question is how the super wealthy fit into the calculation of where the middle class starts and ends. The ultra-rich represent only the top 1%-3% of all Americans, but their extreme wealth skews the numbers, right? That’s true, so in an effort to account for that fact, a lot of the research leaves them out of the calculation of middle income, for good reason. The upper middle class are very different from the super-rich because it is very possible to move up the scale from lower middle class to middle class, and from middle class to upper middle class. Investing in more education sometimes is the key to this climb, but often it is simply the result of starting and being good at running a business, taking calculated risks or pure grit and determination. One fascinating factoid I uncovered in doing a lot of research for this article is that a common tactic in moving up the wealth ladder is to eliminate (not reduce) all debt. Obviously, this means you would also be living within your means at all times, at any income level. Almost all cases where someone was successful in moving up the ladder, they stressed this as being an important tactic that they used, with great success, so I think it is worth mentioning.
I know; I can hear your thinking; the middle class are generally working people who earn enough income to be comfortable and enough income to save and invest some of that income for a modest but secure retirement. They are the retirees who worked for 35-45 years, who have paid off their homes, have pensions, Social Security and enough savings and investments to supplement the pensions and Social Security. This is true for older Americans, but this picture is changing rapidly.
According to the US government, wealth is defined by income, not net worth. In other words, by how much you earn, not how much you have in assets. So, a retiree without any income from work is not included in this definition. This is because the government usually focuses on earned income as part of a plan to tax that income.
Government definitions of middle income in the US have varied. During the fiscal crisis, Congress defined the American middle class as a household with earned income of less than $450,000 so that they could pass legislation to enact tax incentives and federal spending cuts in 2013. President Obama defined middle class as households earning less than $250,000 but also did not offer a minimum on the low end of this scale and President Trump is now defining middle class as households with earned income of between $75,000 and $225,000. This last set of numbers may be closer to accurate, according to other research I have found, which state that average earned income in the US is between $59,000 and $62,000, depending on some variables.
On the other hand, the US Census Bureau measures net worth, not income, to define wealth. It takes a census every 10 years. The last US Census was in 2011, so we are about half way past the middle of the time period towards the next census.
The US Census Bureau says that the median net worth of American households (in 2011) was only $6,676 for people under age 35, $35,000 for people age 25-44, $84,542 for people age45-54, $143,964 for people age 54-64, $194,226 for people age 65-69, $181,078 for people age 70-74 and $155,714 for people over age 75. Remember, those were 2011 numbers, and they are net worth, not earned income. Net worth is all of the assets that you own, such as your home, cash in banks, the actual value of your retirement plan and investments. It is not Social Security or your pension; those are income numbers, not net worth numbers. Remember also that “median” is not the same thing as “average”. It means that 50% of the people have more net worth and 50% have less than the published Census Bureau numbers.
One of the variables is how large your household is; it adjusts your measure of being middle class by adjusting your household income to the number of people in your household. The average household in the US consists of 2.5 people so larger households will require more income. The Pew Research Study on who is middle class in America found that middle income ranged from $42,000 to $125,000 in 2014, depending on household size and geographic location. Lower income households had less than $42,000 on which to live and upper income households had more than $125,000 on which to live. Where you live is part of that equation, too. You will need more income to live in New York City, Honolulu, Los Angeles and Jackson Hole, Wyoming in order to fall into the middle class, because the cost of living is much higher in those places than in other areas of the country. It costs about 23% more to be middle class in Honolulu than the national average costs of living as middle class. You can calculate your own status as middle class (or not) by going to the Pew Research Center’s calculator, click here.
Another study done by CNBC looked at specific cities in the US to determine the cost of being middle class in each one. You can see the details - click here. For example, to be middle class in Alaska, a household of one person requires income of from $25,485 to $76,453, depending on exactly where you live in Alaska. A household of 3 requires $44,139 to $132,419 and a household of 5 needs $56,985 to $170,953, also depending on where in Alaska you live.
The CNBC study has numbers for every state, so you can go there and see what it looks like for your state. The differences in amounts generally are related to where in your state that you do live. In Colorado, a 1 person household needs $24,571 to $73,7112, 3 person households need $42,557 to $127,672 and 5 person households need $54,942 to $164,824 to be middle class. In Connecticut, 1 person households need $26,086 to $78,256 while 3 person households need $45,180 to $135,543 and 5 person households need $58,329 to $174,984 to be classified as middle income. West Virginia requires $21,253 to $63,759 for a 1 person household, $36,811 to $110,433 for a 3 person household and $47,523 to $142,568 for a 5 person household to be middle class. Some states’ numbers are rapidly moving targets, like Washington State, as a result of the huge influx of high income technology workers moving into the area around metropolitan Seattle. San Francisco is experiencing the same thing. The high wages being paid to these workers is driving up real estate prices, resulting in high rents, trendy shopping outlets, expensive restaurants and bars, and higher home prices. The cost of living in cities with this kind of demographic is rising rapidly, so it requires more and more income to stay in the middle class in cities where this is happening.
Younger households will spend the first 10-15 years paying off student debt, saving for their first home, having children, buying cars by borrowing money and paying down credit card debt. During the next 10-15 years, the same households will begin to contribute to retirement plans, college funds and a mortgage. By their mid-50’s most people will be entering their peak earning years, so from there to age 65 most will contribute much more to retirement than to anything else, and many will pay off their mortgages entirely. For the next 10-15 years, most people will stop contributing to retirement plans and begin to withdraw from them. After age 80, most middle class people will have begun to deplete their principal of total investments and retirement plan values (not including pensions or Social Security, which offer no principal values) which will cause their net worth to begin to decrease.
Most studies of how Americans manage their wealth indicate that we are better at accumulating than at planning the distribution of our wealth at retirement. In other words, we appear to be able to save and invest for the future but when it comes to making that nest egg last for our lifetimes, we spend it down too fast and run short, or in some cases, we run out entirely and end up with just Social Security and/or a pension that is not enough to live on comfortably. In these cases, a household or individual may start out at a high point on the middle class scale and drop a rung or two just because of a lack of careful planning around the income we expect from our wealth. This is probably due to failure to know how to calculate a safe withdrawal rate from whatever lump sum of value we have, resulting in depletion of the principal. A carefully planned rate of withdrawals prevents a retiree from running out of money.
In summary, what are the important takeaways of this story? Here they are:
1. The American middle class has not shrunk as reported in the media. Instead, it has expanded to a much bigger range of income and net worth and is now split into 3 levels, upper, middle and lower.
2. The poverty level has dropped. That is good news but the problem still exists.
3. Middle class people have variable net worth depending on their age. Net worth generally increases with age for the middle class who work until normal retirement age
4. The upper middle class is increasingly being referred to as the “mass affluent”, with incomes of from $125,000 to about $400,000. There is not enough data yet to indicate whether or not their net worth will be corresponding larger as well; they tend to be younger and they self- report problems with overspending.
5. Lower middle class people can climb to the middle class and middle class people can and do climb to the mass affluent level, due largely to higher education levels and technology/training in technical skills that are increasingly in great demand. Few people move up from the mass affluent to the super rich, however.
6. Americans are better at saving and investing for accumulation than they are at making retirement income withdrawals at a sustainable rate. They are tending to spend their wealth down too rapidly and are in danger of depleting the principal of the wealth that they have accumulated.
7. Wealth in America is a combination of income and net worth. Middle class Americans average income levels of between $50,000 - $75,000 and average net worth starting out at about 10% of income and growing to about 10 times income by age 65-70.
Where you fit in this big picture is not written in stone. If you are trying to move up the wealth ladder, all the studies indicate that doing so is possible. Just get started and stick with the plan.
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