“How much money do you make?” We don’t ask people that question, but we’d love to know the answer. In this country, we’re fixated on a person’s annual income. That’s the primary measure we use to determine social status and define success.
Income also is the qualifier for government welfare programs. It defines people as poor, middle class, or rich. And, of course, it determines how much of your income the government will take. The more you bring in, the higher the percentage of your earnings you will pay in federal, state, and local taxes. When you file your taxes get a PAN card, the pan explained here and how to it can be help for you.
While we project a lot of things onto someone’s income, most of what we project is untrue. Income is not the best indicator of a person’s wealth or net worth.
Consider these two real-life examples. Last year Brent’s tax return showed an adjusted gross income of $20,000. Bill’s was $2 million. Who is richer? Most people would say Bill. The US and state governments also would say Bill. Actually, Brent is far and away the wealthier of the two.
Bill lives in New York, New York, which has both high property taxes and a city income tax. Paying city, state, and federal income taxes, plus property taxes on his luxurious home, takes around half of his salary. With take-home pay of about $1 million, Bill spends $1.2 million a year on his mortgage payments, college and private school tuition, and his lifestyle. He overspends his net income by $200,000 a year. He owes more on his condo than it’s worth, and he has significant credit card debt. When you total his assets and liabilities, he has a negative net worth of $1 million. He has managed to hold everything together so far, but technically, Bill is bankrupt.
Brent lives in Rapid City, South Dakota. He is retired, owns a modest home which is paid for, and lives on about $40,000 a year. He didn’t pay any income taxes last year, partly because some of his income is from tax-free municipal bonds and mostly because he wrote off a large investment loss which left him with $20,000 of adjusted gross income. Brent has no debt. His net worth is $5,000,000.
The truth is that what people make tells us very little about whether they are rich or not. In these examples, judging from income alone, it would be easy to reach the inaccurate conclusion that Bill must be far wealthier than Brent. His lifestyle is certainly more lavish—which of course is part of the reason he isn’t wealthy.
Many people who have high incomes but are heavily in debt might have lifestyles lower than others who make significantly less but have no debt. It’s not uncommon that people with high incomes choose to live a lifestyle that is far below what they could afford. In fact, this is one of the best ways to build real wealth.
Income is a poor indicator of whether someone is rich. Even more important, it’s a poor indicator of how they handle money. I once worked with a family with an annual income of around $5 million who had a net worth of minus $3.5 million. They may have looked like “millionaires,” but they were not.
On the other hand, I work with many clients who have annual incomes around $100,000 a year, spend $60,000 a year, and are worth $2 to $5 million.
The bottom line is that wealth is defined by net worth, not income. A high income doesn’t equal wealth; it equals a better opportunity to build wealth. Not everyone is wise enough to take advantage of that opportunity.