Taxation: Four People

Taxation can look different in the lives of different people. Here, we will compare the lives of Eric, Marie, John, and Jen.

Early Life

Eric was born into a lower-middle-class family. After his parents paid for the essentials—rent, food, transportation—there was not usually much left over to do anything else. He went to college with the hope of elevating his situation, but he had to take out loans to do so. 

Marie did not necessarily grow up “rich,” but she certainly lived a comfortable life.  Her parents stressed saving and investing.  They even put aside enough to partially pay for her college education. With the help from her parents and by holding down a part-time job, Marie was able to eventually graduate from college debt-free. 

John grew up in a family not too different from Marie’s.  He attended college on a volleyball scholarship. After two years, he decided to drop out to be a professional volleyball player. 

Jen was born with a silver spoon in her mouth. She is what they call “old money.” Since she was young, her parents have been transferring wealth to her.  By the time she decided to venture out on her own at 20 years old, she was already a multi-millionaire.

Working Years

Eric works a typical administrative job.   He lives paycheck to paycheck.  He is able to bring in a decent income, but with his crushing student loan debt and the hefty payroll and income taxes, he isn’t left with much money after paying for the essentials. His wife doesn’t work because, frankly, after taxes, her entire salary would go to paying for childcare. Eric works for 40 years without being able to set aside much for retirement. 

With Marie’s affinity for personal finance, she naturally finds herself working in accounting.  As she works, she contributes as much as legally allowed to her 401K, a tax-deferred savings account. This allows her to reduce her income and payroll tax bill by decreasing her taxable income. She also maxes out contributions to her Roth IRA and invests in appreciating assets. Although these investments are not tax-deferred, she wants to make sure she has a nice nest egg in retirement.  She saves up money for a downpayment to buy a home, which will be paid off by the time she retires. She does this for 40 years or so. 

As a professional athlete, John only works for 8 years. John makes about $200,000 a year. Over John’s short career, he is going to make the same $1,600,000 as a person making $40,000 over a 40-year period, but he’s going to pay a lot more taxes.  Since John is bringing in large paychecks, he is going to be in a higher tax bracket, subjecting him to higher tax rates. John also contributes to retirement savings plans and invests, knowing that in due time, paychecks will be scarce.  He is able to contribute $6,000 a year to his tax-deferred traditional IRA, which saves him a couple thousand in taxes during those 8 income-earning years. 

Jen also doesn’t work the traditional job. She does not need a paycheck, as she has plenty of wealth. She has a team of wealth managers and tax advisers making sure that her wealth is growing and concentrated in appreciating assets, which she is advised to never sell (Buy, Borrow, Die). This allows her to spend her time focusing on humanitarian efforts, while her lifestyle is funded by debt.

Retirement

When Eric retires, he relies mostly on Social Security, which he paid into through payroll taxes during those 40 years of work. It is not much, but he makes do.  He works odd jobs from time to time to keep himself busy and make some extra money. His children also chip in to help him make ends meet when he occasionally falls short on the bills. 

Marie is able to retire with enough money to allow her to live comfortably and do some of the traveling she was not able to do when she was working. She is now funding her lifestyle with the wealth she’s stored up while she was working. The tax finally comes due when she withdraws from her tax-deferred accounts. However, she is taxed at a far lower rate since she has decided to live on around $50,000 a year, much less than what she brought in while she was working.  She also has post-tax funded retirement savings accounts, which she can withdraw from tax-free. On the back burner, she has plenty of wealth stored in stocks. She does not want to sell them and trigger capital gains taxes, so if she ever needs to tap into that wealth she will merely borrow against it. 

John’s retirement looks similar to Marie’s, although he has a lot less saved up (and a lot less interest and capital gains growth) due to his short career. 

Jen has always kind of been “retired.” In her later years, she continues to Buy, Borrow, Die. Her financial advisers have done well enough, so her wealth has grown immensely. On average, she saw her wealth grow about 11% a year. She lived on about 3% of her growing wealth a year (through borrowing, of course), in order to reserve wealth for her kids, grandkids, etc. While 3% may not sound like much, it still affords Jen an extravagant lifestyle given that Jen is well within the top .5% of income. Jen has begun gifting wealth to her children – emulating her own parents – and teaching them Buy, Borrow, Die, so they can repeat the cycle.

Death

Eric never managed to save up much while he was alive, so there is not much to pass on at his death. 

Marie’s nest egg allowed her to live a comfortable retirement. She wills the remainder, along with her fully-paid home, to her kids. They pay no estate taxes because her assets fall below the $11.7M exemption. The home has increased in value more than $200,000 since she bought it.  Her kids receive the home at a stepped-up basis, so when they sell the home they pay no capital gains tax, keeping all the proceeds. 

John dies with a bit left of his nest egg too, leaving it to a couple of his favorite charities.

Jen’s financial advisors and attorneys have been working hard to prepare for her death, scheduling gifts and setting up trusts and holding companies, to minimize estate taxes. Her kids receive an interesting mix of assets (at a stepped-up basis), including fine art, foreign homes, precious jewels, and vintage wines. They sell some of those assets to pay off the large pile of debt that comes from a lifetime of lavish living, and they continue the Buy, Borrow, Die cycle with the rest.

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