Many people use the words income and wealth interchangeably. Often people say the word rich meaning they have wealth versus they have income. This is an association with professional athletes, and high income professions such as doctors and attorneys. However, nothing could be further from the truth. I’ll focus on taxes and retirement savings to show the difference.
Wealth tax and income tax
When many people hear taxes they immediately think federal income tax. The federal income tax is not so straightforward and how people are taxed. Many Americans’ income is based on income sometimes referred to as earnings in the world of taxes. When it comes to tax on income the highest tax rate is 39.6% and the lowest tax rate is 0. Let’s say your job pays you $500,000 and you pay the highest earned income rate (marginal tax rate of 39.6%. It was nice that your contract said that you would be guaranteed $500,000 but due to the tax bite you only net $300,000.
In contrast, if your income came from the wealth tax (long term capital gains), you would net nearly $100,000 more money just by the way you contact investments you had made then you would only get taxed 20%. You would make an additional hundred thousand dollars.
Some people who are new to making income can be a victim of this miss interpretation potentially making promises to others or taking on debts only to find out what I’ve quickly explained.
Retirement savings is not retirement wealth
I have heard some people say people refer to 401(k) or IRA as retirement wealth. In my experience, few people have come up with a retirement income plan that is sustainable. If you have a pension that doesn’t go bankrupt, you will continue to receive income for life. If you have $1 million in a retirement balance that requires you to use it for your income, then you don’t have wealth. Many people are unaware that if the money is an IRA or 401(k) it has never been taxed. If you pull out hundred thousand dollars you will pay tax on hundred thousand dollars, which today would be 25%. If you set it to use the whole thing you’d asked a up to 40% and it would only be worth $600,000. If you leave it invested in the market you will see it go up and down with the market. Pulling money out during down markets will more quickly exhaust the balance.
These examples show how from a tax standpoint, it’s preferable to be wealthy than income rich.? I recommend a custom designed financial life plan where you defined what you think wealthy means on your own terms. Envision Wealth Planning helps people make more enlightened financial decisions to help them pursue their financial life goals. Hopefully you’ve been enlightened regarding income and wealth and would like to contact us to learn how our Envisioneering financial process might help you reach your financial life goals.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.