By all the conventional measures, I look poor. I live in a poor neighborhood, I drive a 7 year old car I share with my ex wife and just rode my bike to see someone I am dating. I cook almost all my food myself, I don’t have any expensive hobbies and I don’t often buy new clothes. Some people would say my life is even kind of sad as I sit in the dark writing my blog so that my son can fall asleep in my studio apartment.
But looks can be deceiving. Despite looking humble by all appearances, I make a good income but I choose to live like this for a few reasons. One is that it keeps me grounded. I never can get too big a head when I remember where I lived when I didn’t have much. The other is that living simply allows me to take advantage of a host of subsidies and tax breaks to grow my net worth, even if I struggle to make more money. Even with a modest income as long as you can achieve stable work, there are a host of incentives that can get you to the next level in terms of wealth which I want to discuss here.
The government taxes many of us a lot. Those of us that have to earn a wage for a living are taxed at much higher rates than those who can live off of their investments. However, over the years the government, both federal and local, has launched tons of initiatives to try to assist working people in many of those big life goals that may seem daunting for someone on the median NYC household income of about $50,000.
The government offers tax breaks for college, tax breaks for retirement savings, subsidies for housing, and thanks to the Federal Reserve, Fannie Mae and Freddie Mac, the government backs the mortgage market, offering ultra low interest rates that even national governments cannot achieve in US dollars. The even offer a tax break on the interest you pay on those same loans that they back. Yet the poor, the working class and even much of the middle class seem to take little advantage of any of these breaks
Retirement Help
The average 401(k) balance as of 2019 end was about $112,000. This seems small, but that could potentially be because it’s an average and there may be many young savers who haven’t saved enough for retirement yet. According to Nerd Wallet though, even if you break it down by age, those 60-69, who had the highest balances of all, had an average of $174,100 in their accounts and a median value of $62,000. The original intent of the 401(k) was to supplement a pension and social security but pensions are all but extinct for many private sector workers and social security isn’t going to cut it for most people in retirement.
The biggest payout you can receive for social security in 2021 is $3,895 per month. But this figure is for someone that earned close to the maximum income for decades and deferred their social security until 70. Most won’t get near this. The average check as of May 2020 is $1,390.
With a few hundred thousand and a $1,400 check, how can anyone expect to make it through retirement nowadays? The answer is they don’t and they won’t. The sad fact is that many will have to live on limited incomes, work much more into old age or rely on family to care for them when older. Despite all the tools we are given to keep this from happening, most people don’t achieve it.
At the same time, Bank of America reported that 80% of wealth is healed by households over 60.
So what are these wealthy, older households doing that sets them apart? The answer is many of them are simply taking advantage of tools right in front of them. You can contribute up to $19,500 in a 401(k) in 2020 and employers usually throw in some matching funds there. Let’s say you made $80,000 a year and your employer matched up to 3% of your salary in your 401(k). You could save a maximum of $21,900 a year. If you simply invest that in an index like the S&P 500 and let it compound at the average long term rate of 10%, you would have over $1 million by the end of that 20 year period.
The difference between those that do this and those that don’t are a bit of luck in keeping a steady job and diligent and consistent saving and investing. That’s it. The rich know that they are giving up consumption today for the benefit of tomorrow. They are making a conscious vote towards optimism for their future and not letting the quick sugar rush of a new car or a bigger house distract them. The government rewards them for this and they usually end up paying less taxes for it. This is because the retirement income is usually less than their wage income so even though it’s taxed like a wage, it may be taxed at a lower rate.
I haven’t even touched on the Roth IRA. Many wealthy, or those that will soon be wealthy, open IRA’s for their children the moment they start working in high school. They then contribute to their Roth based on their income since it is usually lower than the maximum allowed. Even if that child then goes on to become well off enough to not be able to contribute to a Roth IRA. The funds from their youth have a chance to compound for at least 49 years if they start working at 16. That could turn a single $2,000 contribution into $80,000 to $100,000 by the time that child turns 65. Small decisions, big impact.
Breaks on College Expenses
My ex wife is a well intentioned person, but I failed at convincing her that sacrifices now, payoff many times in the future when you are smart. Unfortunately, I am the minority in this thinking. 529 plans allow families to save and invest for college expenses and avoid taxes on the gains if they follow the rules in using the funds for education. Yet only about a third of adults have even heard of a 529 plan. Only about 18% of children under 18 are even the beneficiaries of a 529 account and 7 out of 10 families that have a 529 plan make more than $100,000 per year. As I have discussed in previous posts, the issue with college subsidies and tax breaks is that most people who went to college are middle class or upper class. Any tax break or subsidy for them is a giveaway to the middle and upper class. It’s such a giveaway to the rich that Obama even considered scrapping the 529.
The 529 plan is just one way success breeds success. Those that are likely educated and wealthy are given a tax break to save for their children who are also likely to be educated and wealthy. Meanwhile others load themselves up with student debt or hope for scholarships in order to be able to trudge their way through college.
Low Interest Rates
So who benefits the most from low interest rates? Well in the aggregate most everyone does, except pension funds and those who need to live off of interest income. But the big gains trickle up to the wealthy.
This dawned on me when I was explaining to someone my slightly odd hobby of collecting bank notes from around the world. My prized possession in this collection is the $100 trillion bank notes printed by the Central Bank of Zimbabwe, the highest denomination bill ever printed. I explained how in hyper inflation the rich are able to make outsized gains because they have the means to hold stable offshore currencies, invest in hard assets like real estate that retain their value in inflationary times and borrow in the initial period of inflation at fixed rates. This allows their debt to become cheaper and cheaper over time until it is simply a pittance to pay off. They may use the borrowed funds to invest in those same assets like real estate or foreign currencies which will retain their value even while the loan is inflated away.
This brought to mind the situation now with low interest rates. I was quoted a 2.9% interest rate on a refinance of a 30 year loan today. Not only did the pandemic and low rates push up the value of a suburban home I own, it made it even cheaper to get that new equity out.
It’s those with assets and good credit that will be able to really tap into the advantages that low rates offer, and those people are usually, you guessed it, the wealthy.
Housing Subsidies
To make matters worse (or better, if you benefit) the mortgage interest deduction means that you can deduct that interest from your income taxes if you use the home as your primary residence. This is one form of a housing subsidy. The other, that is unique to NYC is getting in early on a a cooperative apartment with income caps when you have a low wage. I did this many years ago which I was lucky to have kept and has proved invaluable post divorce. Due to the income restrictions for those initial buyers, the building receives a subsidy in the form of lower taxes that I estimate help me pay a mortgage and maintenance that are about 40% below the market rate of rentals in the area. Past studies have shown that most of the mortgage deduction as well as the NYC housing tax breaks end up sitting with the middle class and wealthy and not for the working class or poor they were intended for.
So Many Loopholes
The moral of me explaining all this is that there are literally tons of ways to become wealthy slowly and through a regular job if you take the time to educate yourself on the different ways that local, federal and state governments are trying to help you out. If you don’t make a millionaire salary, it only takes what some consider to be a humble life for a while to get you there. Despite all the ups and downs of my past few years, the markets have literally brought all the money back I lost in a failed business, my divorce and my settlement. My divorce even made me step up my savings to take maximum advantage of some of the savings I described above. I estimate that a quarter of my income now is either untaxed, tax deferred or just a plain giveaway I get by taking advantage of every program or legal tax loophole I can find. I literally doubled down on my saving and investing strategy in hard times and am a bit surprised to see the rewards coming back this quickly.
Unfortunately for those that make excuses in order to spend on themselves now, the recent market highs have been another example of a wasted opportunity. While many people chase looking rich, others chase getting rich.
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