Two-Income Trap: Why Many Couples Shouldn’t Both Be Working For The Money

No doubt you have heard of the Two-Income Trap. I think a major issue that is often overlooked with the Two-Income Trap are taxes. I come from a situation where when it came down to having kids and wanting a spouse home, we never saw much of a loss going down to one income because the second income would have entirely gone to taxes and daycare.

Obviously, this determination depends on many factors, but being a financial professional and having people come to me for financial advice I get to see the intimate details of many families’ finances. It is amazing to me how often people are taking home gross pay significantly more than us on 2 incomes, but take home less than us at the end of the day when it comes to daycare, taxes, and the other expenses of working.

I think part of the problem is that the tax code is so complex and taxes are so little understood by the average person that most people don’t realize how little they are really working for at the end of the day with a two worker family. We have found it far less stressful, and more economical to try to bring in another few hundred a month on the side, rather than through all the energy and effort of a second full-time job.

There are two things to remember when it comes to taxes. First off, social security taxes of 6.2% are subtracted from the first $97,500 of your pay. Medicare taxes will eat 1.45% of your paycheck with no limits. What this means is that in most cases, a second wage will be hit by 7.65% in taxes right off the bat. While this is the case for most people with kids or not, much too often people look at their second wage gross pay with little regard for how much they actually get to take home.

The other consideration is the income tax brackets. During 2007-2010 people can get away with a lot more in a second income without jumping up to the next tax bracket due to the Bush tax cuts. But from a professional standpoint, these temporary provisions are due to “sunset” in 2010 and there is no indication that they will be extended.

What this means is currently the first $64k of your taxable income is taxed at a rate of 10-15%, and the next $64k you make as a married individual will be taxed at a rate of 25% per a tax calc tool. Even at these rates, you can see that a second wage in many cases will be taxed at a higher 25% Federal tax rate. When you look at pre-2000 tax rates, and where rates will most likely be in the future, it is even worse. Going by these as a reference, only the first $43,000 will be taxed at 15%, and the next $65k or so will be taxed at 28%. For the longer term, these are the tax rates we are looking at, and it puts a much larger dent in the second income of a married couple.

But let’s look at it from today’s standpoint. Throw in some state taxes (assume 3%), and if you make $60k per year and your spouse makes, let’s say $40k, and right from the start the couple only gets to keep 65% of their second pay-check, or about $26,000.

Now if you throw in a child into the equation, you also have daycare to consider. In the area where we live, daycare is insanely expensive. At the least, care for an infant would be $12k/year. Forget anything fancy or upscale. If you are only having one kid, and live in an expensive area, you can still probably justify a second job in order to keep $14,000 a year (after daycare expenses). But doesn’t it make you pause? Would a part-time job be easier? Do you need that entire $14,000? Is a full-time job really worth it?

When you throw two kids in the mix, it really gets interesting. Maybe by the time you have two kids the older kids care will be cheaper, or you will get a sibling discount. So say you pay $18k/year in daycare and then you would get to keep $8,000 a year of a $40k wage. I didn’t even get into the expenses of working, like gas and professional attire, etc. Add all the added costs of convenience, after being exhausted from the demands of 2 working adults (are you really going to cook dinner every night to keep costs down?) and you can see how a second job can start to amount to nothing for many working parents. In some cases it can be more of a drain than more income.

There are, however, exceptions to the rule. You may find extremely cheap childcare (perhaps a family to care for your children or your work provides it at no cost). You may be able to fund a 401k with most of a second income, to save income taxes. You may be able to find better benefits with a second job, which could save thousands a year. You may not mind a life of working opposite shifts to avoid daycare costs. There are many, many things to consider.

While these exceptions do exist, I know too many people who aren’t really looking at the big picture and what a drain a second income has become to their family. I know too many people who really wish they could be home for their kids, but think they need that extra $40k/year (that is really $0 – they just haven’t looked very closely at it).

For us, we knew in the early years we wanted to have one of us home with the kids. We saved a considerable amount of cash to bridge the gap. But even more importantly, we did a lot of tax strategy. I am a tax accountant, so it just seemed the obvious thing to do. With another dependency exemption, the child tax credit as well as the loss of the second income, we decided I could squeeze another $400/month out of my paycheck easily by changing my withholding allowances to reflect our new little deduction. We had to give up our usual tax refund at the end of the year, but in essence gave myself a nice raise to help cover the absence of a second income.

I know too many people around here making $100k who only get to keep $70k after taxes, and they shell out really big bucks to daycare on top of that. I always find it ironic that many seem jealous of our lifestyle. The assumption that I must make six figures to have a spouse that can stay home. The fact is we had many years in the $50k range, but some of those years I took maternity leave and got to keep over 95% of my paycheck (with the refundable child tax credit).

Today I make closer to $70k, but since we aren’t being slammed with taxes (we would be with a second wage) I get to keep on average 90%. This is a very short-term situation, but illustrates a big problem of the 2-income trap. I get to keep a larger amount of my income because I make less. There are also no (expensive) childcare considerations. On top of that I have a spouse who is home 24/7 to take care of the household, grocery shop, and cook dinner. We find it very easy to rein in costs as we have plenty of time to shop around and pursue more frugal endeavors, rather than settle for more expensive conveniences.

In addition, we lead a much more relaxed lifestyle which means less medical expenses from stress and a busier lifestyle. We enjoy a higher quality of life. We find it far easier to focus on bringing in another few hundred dollars a month on side endeavors and hobbies that the drain of a second full-time job and the added stress that it could put on my job (more sick days home to care for children – sick days and daycare vacation days – shuttling kids to daycare, etc., all which takes great time, and in the end could depress my wage).

On the flip side, and to be perfectly honest, I am not sure we realized when we decided to take a short-term hiatus from 2-incomes how hard it may be to find a second income again down the road. Since in our family it is the husband who stays home, we have found a pretty huge brick wall when it comes to a little side income. My maternity leave was unexpectedly extended after our second child and we weren’t too worried as I figured my spouse could go find some part-time or temp work to bring in a little extra money in the meantime. In his short job hunt he came across a lot of resistance as he was really too over-qualified for part-time retail or temp work. At the same time I think the discrimination that he faced since he took a break from the workforce was even worse. I do not know if it is any easier for women, but we really got the impression that this will be a big stumbling block when he is ready to return full time. In our case we were prepared enough and thought enough through that it does not worry me terribly, but I do share because going down to one income on a temporary basis can become a much longer-term drain than you ever initially considered.

For now we wonder if we will ever see the point of working two full-time jobs again. This is due to many things that have changed over the last few years, including my earnings power increasing faster than expected. But all the same, a long-term lifestyle was never a consideration when we made the 1-income leap. So it is best to look at as many angles as you can before making such a leap. One thing that I will always respect about the many friends I know who were unwilling to make the 1-income leap is that there was some sense of longer term financial security that they weren’t willing to risk. I guess this is my attempt to share both sides of the story the best I can.

I did want to share though that I recently came across the most comprehensive calculator I have ever seen about the true costs of a second wage. I found this calculator interesting because it seemed to accurately reflect tax considerations (though this reflects tax rates from a couple of years back), as well as many other often overlooked expenses of a job. It certainly discounts most of the longer term affects of quitting a job or leaving a career for any length of time. For many of us who feel it is worth the risk to be there for our kids, but feel it is just a little out of our financial reach, it is something to consider, to see that working may be costing you far more than you ever realized, or that maybe it isn’t as far out of your reach as you thought.