More from The Millionaire Next Door: Following the statistic I pointed out in the last post, “[The average millionaire's] total annual realized income is less than 7% of their wealth”, I wanted to post an excerpt from the book that elaborates on why they realize so little of their income. It’s a lengthy passage, but learning and applying the principle taught in it will save you lots of money and teach you one of the “secrets” of the wealthy.

The typical millionaire in our surveys has a total annual realized income of less than 7 percent of his wealth. This means that less than 7 percent of his wealth is subject to some form of income tax…Millionaires know that the more they spend, the more income they must realize. The more they realize, the more they must allocate for income taxes. So millionaires and those who will likely become affluent in the future adhere to an important rule:

To build wealth, minimize your realized (taxable) income

and maximize your unrealized income

(wealth/capital appreciation without cash flow)

Income tax is the single largest annual expenditure for most households. It is a tax on income, not on wealth and not on the appreciation of wealth if this appreciation is not realized; that is, if it does not generate cash flow.

What is the message? Even many high-income-producing households are asset poor. One reason is that they maximize their realized incomes, often to support high-consumption lifestyles…It takes much discipline to become affluent. We have interviewed many people worth $2 or $3 million who have total realized annual household incomes of less than $80,000.

How much does the typical American household realize in income each year?…nearly the equivalent of 90 percent of its net worth. The result is that the typical household in America pays the equivalent of more than 10 percent of its wealth in income taxes each year. How about the millionaires whom we surveyed? On average, their annual income tax bill is an amount equal to only a bit over 2 percent of their wealth. That is one of the reasons they remain financially independent.

So, to recap: income tax is a major expense for the average American household. Millionaires reduce the amount they pay be directing their money into investments, rather than consumption, and live off less. Their money is then able to earn interest and grow their personal wealth rather than the government’s.

Tags: Millionaire Next Door, realized income, Thomas Stanley

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