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FINANCIAL
INDEPENDENCE: What
is Rich?
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Money
In vs. Money Out
 I
used to wonder how it was possible that lottery winners
most often ended up broke and deeper in debt than before
they won the jackpot. How was that even possible? How
could people spend so much money? But when you really
look into it, it's actually very easy to do.
Imagine
you won the lottery today. We'll be conservative and
say you won a $3 million jackpot. Most financial advisors
recommend you take the lump payment, because if invested
wisely, you can get a higher rate of return on the money
than the installment payments made over a typical 20-year
period. In that case, you usually only get about half
of the dollar amount, which amounts to $1.5 million.
Still not bad ... you're still a millionaire!
Lottery
winnings are taxed an automatic federal withholding
of 27%, right off the top. The actual check you get
will be for around $1,005,000. Everything's still okay
... you're still a millionaire.
Lottery
winnings are also subject to state and local taxes.
(Does your state have an income tax? And, no, it doesn't
matter if you move after you've won.)
Okay,
so let's say you still have somewhere around $1 million.
What are you going to do now? If you're like most people,
you already have a list of things you'd buy with that
money ... a brand new car (for each member of the family),
a dream home, a vacation villa, a trip to Europe, a
new wardrobe, a yacht ... etc., etc.
 Let's
be honest, you didn't take that $1 million and invest
it, did you? Of course not.
Those
brand new cars required insurance and tags. That dream
home and vacation villa needed furniture, a home theater,
perhaps even an interior decorator, since a millionaire's
home should look, well, like a million bucks! That trip
to Europe was first-class all the way, wasn't it? What's
the point of buying a brand new wardrobe if you can't
wear it out to the finest restaurants, the opera, the
grand opening of that new musical, etc.? And that yacht
doesn't take care of itself — there's docking and
maintenance and all kinds of fees you hadn't counted
on, weren't there? Don't forget those generous charitable
contributions! Every charity and long-lost relative
you've never heard of came knocking at the door, and
you didn't want to be selfish, did you?
When
the end of the year rolls around, you're stunned to
discover you owe hundreds of thousands in taxes. How
is that possible? Surely the 27% off the bat covered
the taxes on your winnings, right?
Wrong.
Not even close. You should have consulted with an accountant
like all those money magazines advise. Now you're swimming
in tax debt and penalties for not making your quarterly
estimated tax payments throughout the year. You are
now officially in debt. Hope you didn't quit your day
job.
Are
you surprised? Most people are. But remember that millionaires
are taxed more heavily than the rest of the population,
and it doesn't matter how you got the money, or the
fact that you're new to this game. The IRS won't let
it slide just because you're an amateur.
(By
the way, it works similarly with other kinds of large
windfalls — an inheritance or some kinds of insurance
settlements and lawsuit awards.)
Good
News, Bad News
"If
you can count your money, you don't have a billion dollars."
~ J. Paul Getty
 If
you are lucky enough to win the lottery, the good news
is, you're a millionaire. The bad news is, you're not
really "rich." Not in the way most people
think when they imagine the word "millionaire."
Sorry, but a million dollars just doesn't go as far
as it used to.
Most
of us are programmed for "instant gratification."
You know the syndrome — it's when the microwave
isn't even fast enough for us anymore. So, to think
of not spending that money when we're suddenly a millionaire,
when we've been waiting all our lives for "that
magic moment," is beyond our comprehension. But
that's exactly what you need to do, if you really want
to be "rich."
What
rich people know that you don't is that money can only
free you if you don't spend the principal. That
is the secret to being wealthy, so it's worth repeating:
don't spend the principal! You will only be wealthy
once your money starts earning an income for you.
So,
what does that mean? It means delayed gratification.
It means bank accounts, CDs, investments. It means socking
the $1 million away into low-risk investments for a
year, and seeing if you can live on the income it generates
(after taxes).
What
kind of interest rates can you get? If you're lucky
enough to get a 3% return on a bank CD in these days
of low interest rates, or in a money market account,
your money will generate about $30,000 in a year (a
little more, if you leave the interest in the account
so it can compound). Can you live on $30,000 a year?
Remember, that's gross, not net. You will have taxes
to pay on your interest. Lots of taxes — after
all, you're a millionaire! — so figure on about
half: $15,000. (Remember to make those quarterly tax
payments!)
If
you put your money into bonds, you might fare better.
No guarantees. There are risks associated with bonds
and bond funds, as well, and the rate of return may
not match or surpass inflation. Perhaps a portion could
go into stocks, but with the volatility of the stock
market we've seen in recent years, it's best not to
count on any kind of steady income from that avenue.
Stocks are still best as long-term investments, not
for annual income.
Living
on $15,000 a year not quite your idea of being a millionaire?
Not feeling quite so rich anymore? This is reality.
Those people politicians scorn for being millionaires
are living on a budget, just like the rest of us. They
have to plan for their tax bills, they have to deal
with an uncertain income year after year, they may not
be able to quit their jobs without living very modestly,
and they have to take up the responsibility of managing
their money.
 What
it does give them is a measure of peace of mind and
freedom.
Even
if they're still working, they don't have to be overly
worried about being laid-off. They'll still have income
coming in every year, and they'll be fine. They don't
have to work at a job they don't like, just for the
money. They have the freedom to pursue any kind of career
they prefer, work that they enjoy doing. They can afford
to take a risk, without being reckless, by investing
a portion of their money in themselves — starting
a business, going into a partnership, or buying into
a franchise. They don't have to worry about an unexpected
bill or unplanned expense — they can cover it.
They may not be able to afford extravagance, but can
they be happy? Without a doubt, yes.
Budgeting:
Even Millionaires Have To
The
bottomline is that everyone has to budget. The only
way to get out of debt and stay out of debt is to manage
your money. The only way you can get ahead (and stay
ahead of inflation) is to have more money coming in
than going out, save the extra, and have it start generating
an income for you. Until you do, you will always be
at the mercy of your job, of the economy, and of the
unexpected.
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