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Judy Loy: What is Rich?

by on December 02, 2012 6:00 AM

The votes have been counted and the campaign phone calls are a thing of the past, until the next election. Now the question on taxpayers’ minds is “will the fiscal cliff be fixed before we fall off at the end of this year?”

If you Google ‘fiscal cliff,’ you will find more than enough articles available on the topic to keep you busy. Most articles point to President Barack Obama’s main solution for the deficit, and managing the ‘cliff’ is to ‘tax the rich.’ Who are the rich? As of now, he defines the rich as a single person making more than $200,000 or a married couple filing jointly making $250,000 in adjusted gross income.

This level of income pertains to less than 3 percent of the U.S. taxpaying population. One of the proposals is to keep the Bush tax cuts for everyone but this select group of income earners. There is also a push to limit itemized deductions to under $50,000. Such itemized deductions include mortgage interest and charitable contributions and others. A compromise may come into play with the GOP whereby the ‘rich’ are defined as those making over $500,000 annually and the higher taxes applying to those individuals. Warren Buffet suggests this is a better income level to define the term rich. However, if we are to tax them, exactly who are the rich and how should “rich” be specifically defined?

Typically, there are two ways to look at a person’s wealth. One is through their income and the other is through their net worth. Net worth is defined as a household’s total assets minus their total liabilities. For example, if you own a home, your net worth from your home is what you could sell your house for minus the amount left unpaid on your mortgage. A person who has net worth of more than $1 million may be considered wealthy.

According to the book, “The Millionaire Next Door” by Thomas Stanley and William D. Danko, the average millionaire realizes less than 10 percent of their net worth in annual income, and only 3.5 percent of the population has a net worth of $1 million or more. So a household with $1 million in net worth would at most realize $100,000 in taxable income. This is far lower than the proposed $250,000 or $500,000.

The book also categorizes people as PAWs, AAWs or UAWs. PAWs are your millionaires because they are ‘Prodigious Accumulators of Wealth.’ PAWs live under their means and save religiously, typically 15 percent of their income. Instead of spending, they save and have a higher net worth than others in their income category. AAW (Average Accumulators of Wealth) and UAWS (Under Accumulators of Wealth) live at their means or above and thus decrease their net worth possibilities. Dictionary.com even defines rich as ”having abundant possessions and especially material wealth.” However, obtaining things costs quite a bit in true net worth. This is why income levels are usually the choice in the U.S. for determining rate of taxation. If taxes were based on net worth, we would be penalizing people for doing the right thing (living below their means, using debt responsibly and saving/investing systematically).

Therefore, the IRS looks at income, dividends, interest and W-2 income to determine who is ‘wealthy’ for tax purposes. This seems a fair gauge until you look at the people making $250,000 or more. There is a big difference in the cost of living for someone making $250,000 in State College and/or $250,000 in New York City. The cost of living in New York is 43 percent more expensive than living in State College and the biggest difference is the 85 percent higher cost of housing (data provided by bestplaces.net).

Another very interesting view of wealth is whether people view themselves as wealthy or not. A survey of millionaires in 2011 done by Fidelity Investments indicated that they would not feel they were wealthy until they had $7.5 million. I believe many people, including me, would feel rich with far less. According to the Pew Research Center, when asked how much income it would take a family to be considered wealthy, most Americans say a family of four would need $100,000. The median amount indicated by all respondents was $150,000. On a side note: Who are these high income earners? Only 34 percent say they were upper class growing up. The remainders were middle class or lower class, indicating that happily, there still is positive economic mobility in the U.S.

When we review these statistics and public perception, it does seem to indicate that U.S. families consider people ‘rich’ if an individual makes $200,000 or a couple makes $250,000. The next questions are: How much more in taxes should they pay, and, what is their fair share of the tax burden? For these answers, we will need to see how, or if, the fiscal cliff is resolved.

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Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at jloy@nestlerode.com.
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