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There has been a plethora of back and forth in the HD Forum recently about what constitutes income. I hesitate to wade into these stormy seas. But what the heck. I wrote an article a while ago that discussed the various meanings of income that the tax code uses. Head there if you want a discussion of Gross income, Adjusted Gross Income (AGI), Modified AGI, Taxable income, and Combined income.
Right off the bat I’ll state that this argument will never be won. Because income is inexorably tied to taxes, and taxes are mind-numbingly complicated, our individual views of what constitutes income are a source of confusion. I like to think of these primary categories – the examples are illustrative, not comprehensive.
Earned Income – salaries, tips, bonuses, net self-employment earnings, …
Investment Income – interest, dividends, capital gains, rents, royalties, non-qualified annuities, …
Retirement Income – Social Security Benefits, Pensions, withdrawals from retirement accounts like IRAs, 401ks, qualified annuities …
The tax treatment of items within a category are not necessarily the same – think short-term vs. long-term gains. Pensions are taxable, but Social Security Benefits may be partially taxable. Annuities and retirement account distributions that contain an amount of post-tax contributions are partially taxable.
For retirees who continue to work, any earned income is subject to FICA taxes. Retirement and investment income are not subject to FICA taxes. Further, the Social Security earnings test does not consider retirement or investment income. But the definition of combined income, which is used to determine what amount of your Social Security Benefit is taxable, includes retirement and investment income.
And this is just the Federal tax code. States have a variety of definitions of income for tax and rebate programs. Income, like beauty, is in the eyes of the beholder.
I look at funding our retirement as a multi-variate problem. I’m lucky enough to have a traditional pension, Social Security, and financial resources in pre-tax and post-tax accounts. I also have real estate that provides rental income, and could be converted to liquid assets. And we aren’t close to RMDs yet.
I use these resources to fund our retirement. We have non-discretionary and discretionary expenses. To be honest, our discretionary expenses greatly exceed our non-discretionary expenses. To the extent our total expenses exceed our combined fixed income (Pension & SS) I make decisions on how to use our other resources to fill the gap. I make choices considering tax implications, portfolio makeup, and other considerations.
I fully recognize that many retirees don’t have the resources, and choices that I, and many in the HD community, have. I see them every year at tax time. But even people of modest means have some choices, and are required to make some choices. The more they understand, the better their choices, and the higher their standard of living.
Thanks for wading in and pointing out the numerous ways in which income is defined. I couldn’t help but think of a situation in which someone recives their final paycheck on their last day of work and spends it on the first day of their retirement. In the course of one day, earned income becomes retirement income. Or is it simply spending short-term savings?
Thanks. I was thinking about how we characterize savings in this discussion. The Life-cycle hypothesis talks about consumption smoothing, and dis-saving in retirement, basically spending down our savings. I remember several older relatives who kept fairly large sums of cash in a shoebox, or old metal box. They accumulated this over time and used it when needed. It performed the role of smoothing out their consumption.
Great Job!
English is such a great language. Definitions are allowed, even encouraged, to be flexible in everyday use to help people communicate. Unlike my mother who would correct which words I should use to express myself, there is no one who polices how adults communicate in a Humble Dollar type of environment. And, if someone is successful in their own financial affairs they are entitled to use words any way they want to.
However, there are environments which require more precision. When you read a contract, there is always a section that defines what the terms used in the agreement mean. And, when you deal with the IRS, you must understand how they define the language which expresses their rules.
So, even in the Humble Dollar environment, when you refer to topics in the Tax Code, you should follow/communicate your ideas using the IRS definitions.
There is no blended environment. You cannot use the word income without a definition if you also refer to income taxes in the discussion. To do so creates confusion as those who do understand and follow how the IRS speaks will immediately feel a discordant note and write comments.
It is the writer of words who is responsible to be sure that what they write is understood by their readers. When terminology such as the word income is used it is the writer’s job to understand that the word has many meanings and to be sure which meaning of the word they intend that the reader should have in mind.
Thanks for the thoughtful comment. I have a lot of experience in systems engineering. Writing clear requirements that could be executed was always challenging. No matter what I write, or how much time I spend checking it, I invariably find something I wish I had written more clearly, or a point tI forgot to add. Luckily, the HD community is always willing to help. And we happen to have the best editor in the field.
This was good, Rick. We have the same income sources you do, except for the extra house. It will make tax planning important so we can keep more of our money.
One way to consider what constitutes income is what do you tithe on, if you do that. I don’t remember seeing that mentioned in the income conversation. We have had discussions about this as we turn on our various retirement incomes and so far, we still plan to tithe on all sources. Chris
Chris, thanks – that is something I hadn’t considered.
That seems more complicated than necessary. For me there is income – pensions, SS, interest, dividends and RMDs in my case – before tax and after tax. And there is potential income from the sale of assets, reflected in my net worth. I am spending considerably less than my income after taxes. I spent considerably less than my income after taxes before I retired. At some point I may need to increase my income and reduce my net worth by selling assets – that’s what they are for.
I feel that Mr Quinn’s insistence on the importance of income rather than expenses is due to the incorrect belief that people spend all of their income. No doubt that’s true for him, but manifestly not for other HD readers.
Kathy, you make an incorrect assumption. We do not spend all our income.
Regardless if a person chooses to spend or must spend all their income or not, spending is still limited to income – from any and all sources. That’s the only point.
A person can plan and manage expenses all they want, it all has to fit with available resources – income. That was my only point from the beginning.
“spending is still limited to income”
That is a truism, if you exclude debt. If that is your only point it does not justify your insistence that one needs to replace 100% of final salary in order to retire.
Yikes, please don’t go there. That was never part of this discussion. 🤑.
I think Mr Quinn would do much better in his promotion of his slightly obvious worldview and certainly improve clarity if he substituted “cashflow” for “income”. Then those who take a slightly more orthodox view of what income and capital is can understand him.
Kathy, You are right to a degree. Because of our decision to own two homes, and seasonally rent one of them, our finances are more complicated than most. But it’s our decision, and we ae OK with it for now. We may change our minds in the next year or two. We are currently able to access the financial resources we need to support our lifestyle.
Looking back at my original post i have no idea how the discussion deteriorated into differentiating income or claiming some money is income and some not.
Income is income, taxable or not. In this context it is any money a person lives on in retirement. I don’t care if they sell their baseball card collection or Indian head pennies.
No point in listing all the possibilities, but i know for sure my RMDs are income as are other withdrawals from investments. Ask any retiree living on such money if it is their income. My municipal bond interest is also income.
Please don’t trash another thread with your stubbornness. Withdrawal from capital is not the same as recurring income because if you do too much of it, you deplete the capital.
Or put it this way a person can retire with $1m in retirement accounts plus SS. If they treat the $1m as income and buy the Lamborghini they’ve always deserved and the round the world cruise and throw a few flashy parties to impress the golf club, they might have a hell of a year but suffer thereafter.
Now that much is reductively obvious but it’s why it’s important to know that not ” all money is income”.
Yeah that’s all accurate Rick. Some people chart a deliberate course towards retirement and others just drift. And isn’t is amazing how much you can learn about a persons situation by their W2s, 1099s, and 1098s.
Brave man for wading in. You did a good job addressing the topic with clarity. My favorite line: “I look at funding our retirement as a multi-variate problem.” Not sure Mr. Quinn will appreciate that as much as I do. 😂
Multi-variate problem – let’s go back to Calculus 202! How many summations in this computation? 🙂
I remember the concepts but couldn’t do one if I tried.
Thanks Ken. I think an important part of wisdom is recognizing that many folks think differently from me, and that is (mostly) OK. Figuring out things – how big, fast, expensive, … – is one of the primary ways I understand the complicated world around me.