Does it really pay for dual income families?

Terrible Economics for Dual Income Families

by Omie Ismail


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Many families understand all too well the burden of having two working parents. Any debate over whether one parent should stay home needs to include an analysis of tax implications. Of course, some households don't have the luxury of engaging in this debate. Two paychecks are needed to support the family and they simply can't get by without the extra income. But federal and state tax laws penalize dual income households at such a high rate that when the additional costs of commuting, childcare, and work-related expenses are factored in, many families might discover that the second income is just not worth the hassle.

There are non-monetary reasons and long-term economic considerations that factor into this debate but are beyond the scope of this article. There are certainly advantages of dual income families. The spouse that continues to work may have a career that requires working at least part time during early child years. Some people simply enjoy working and can't handle the demands of 24/7 parenting chores. Also, there is always the unspoken fear of a divorce or breakup that compels many women to stay engaged in their careers.

Work experience counts and re-entering the job market after years of absence is difficult and often obliges you to resume climbing the career ladder from the first step. The second job may provide better healthcare than the primary one and there may be long-term consequences for leaving the workforce, even for a few years. Even in these uncertain economic times, the probability of both parents losing their job is still remote. With only one parent working, all the bets are placed on one work horse.

Still, when it comes down to household cash flow, the short-term economics of both parents working are driven primarily by tax policy and the ever-increasing cost of childcare.

With two parents working, the second paycheck gets taxed at the marginal tax rate from the very first dollar and those tax rates, even in the middle-income range are 25-28%. Moreover, both parents pay into FICA regardless of whether one or both are working. This creates another 7.65% tax for both Social Security and Medicare. For a fairly modest income family, the marginal tax rate for the very first dollar from the second paycheck can be 33% or higher depending on how much the first paycheck is. And that's only counting federal taxes. Even for middle income earners, state income taxes range from 0% in states like Florida and Texas to 9.55% in states like California. Living in the Golden State might end up increasing your combined marginal tax rate for the second earner to an eye-popping 42%. Throw in disability as well as employee related expenses such as parking and nearly half of the income from a second paycheck can get eaten up by taxes and work-related expenses.

In addition to the taxes, there are significant costs simply associated with working. A 30-mile round-trip commute to work will cost approximately $3,500 more each year. Additionally, home related expenses may go up as the second job creates the need to outsource cleaning or maintenance. Brown bagging quickly loses its luster and food costs may also increase. Harried working parents are more likely to splurge for pre-prepared meals from grocery stores or restaurants.

For couples with children, there are additional penalties levied on the second wage earner. After the tax man takes his pound of flesh, you still have to deal with the costs of pre-kindergarten childcare. That can run you another $500 to $1,500 each month per child. With two children, this can easily exceed $15,000 a year. Even for school-aged children, the cost of after-school care can be significant at $200 to $400 a month. With children thrown into the mix, the second income earner might end up netting as little as 20% of their gross pay. That percentage might rise to 30% in zero income tax states. To put this in perspective, if the second wage earner working full time is making $10/hour, he or she might be increasing actual household income by a mere $350 a month.

With proper financial planning, you can cover some of your childcare expenses with pre-tax dollars or childcare credits, but that won't come close to covering what you actually shell out for childcare. The Federal Childcare Tax Credit is $3,000 per child and it only applies to the first two children. While these credits are helpful, they only partially offset the cost of childcare.

Interestingly, the economics of dual income get substantially better when both earners make over the maximum FICA amount of $113,700 and are not "lopsided." Upon achieving that rate of income, the marginal tax rate actually goes down by 6.2 percentage points as Social Security goes to zero. For professionals, such as lawyers, the second income likely makes far more sense as it is more than sufficient to support the childcare costs, max out on IRA's and 401K plans, and provides other professional employee benefits. The debate about whether professional women with children should stay in the workforce usually focuses on career advantages. In simple dollar terms, it certainly makes economic sense if the second paycheck is over $50,000 a year.

Millions of second income earners, predominently young mothers, are already struggling with the current high marginal tax rates and increasing childcare costs. Any further increases might result in hundreds of thousands of workers deciding to leave the workforce further reducing tax receipts, dampening the recovery, and threatening Social Security. Such a trend already seems well underway, as more and more mothers decide that the economics of working are illogical for their families.

Given the current tax structures, second income earners might decide to turn to contract work and start small in home businesses. Self-employment income comes with an additional benefit; it allows you to shield a significant portion of your income with offsetting expenses and personal retirement plans that have much higher caps than employer sponsored plans. Cell phones, Internet, landline telephones, and automobile expenses can add up to $5,000 a year or more. Given the 60-75% effective rate of taxation, shielding these in a low revenue home-based business would be much easier than earning an extra $20,000 in a regular job. Furthermore, additional untaxed income can be made providing services for other working parents by babysitting or carpooling.

Even parents that don't bother to do the math instinctively know that they are not bringing home enough after tax dollars to make that second paycheck worthwhile.

After taking into account the long term advantages of bonding with their kids in their early years, many parents might still opt to get by on one paycheck regardless of how much extra income is generated by the second wage earner. It's almost impossible to economically quantify the positive returns of developing a close relationship with your child in their pre-school years. Families that make that choice can be heartened by the fact that they're probably not giving up very much in the way of income by staying at home.

There is another advantage; the stay-at-home parent has plenty of time to clip coupons, shop around at thrift stores, prepare homemade meals and tend a little garden. Stay-at-home moms are professional cost cutters or, dare I say, cheapsters.

updated April, 2014


Omie Ismail is the CEO of LiveCheap.com, a website focused on helping people "Live the Good Life Cheaply." Omie is an entrepreneur, financial advisor, and trusted financial advisor for family, friends, and colleagues. He has been a software CEO and an economist and regularly writes on investing, cost cutting, and family matters for LiveCheap.com.

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