What is income
Income is the money received by a person or household over a period of time. Typical sources of income include salary/wages, government benefits (such as the Canada Child Benefit), and investment earnings.
Once you’ve received income you then have to pay taxes on that income back to the government. So true income isn’t necessarily your pre-tax or “gross” income but your after-tax or “net” income.
Income is useful because it is earned immediately and the more income you have in hand the more you are able to put to work generating wealth for yourself and your family. To get a better understanding of what your net income is you can use my income calculator.
What is wealth
Wealth refers the assets that are held by a person or household at a single point in time. It can include real property (housing/land), shares in a company, jewellery, artwork, pensions, and life insurance. By accumulating wealth, a family will be able to survive without a paycheque for a period of time. Unlike income, wealth is not immediate – it takes time and patience to acquire. It takes saving and investing over time.
The accumulation of wealth can be coupled with the accumulation of debt at times. For example, to purchase a home, we often require a mortgage. As such, a proper determination of wealth looks at your assets less your liabilities – your “net worth”. To get an understanding of what your net worth is you can use my net worth calculator.
Why Wealth is More Important Than Income
Income is the mean by which wealth is generated. This is why wealth is the better factor in determining true financial security. In fact, you can have a high income but low wealth.
For example, if you earn $100,000/year but you have living expenses of $80,000 you will only have $20,000 left to generate wealth with. If you earn $50,000/year and keep your living expenses to $10,000/year then you will have $40,000 left to generate wealth.
Once you begin to generate wealth, wealth works to contribute to your income. You might receive dividends from your stocks or your home might go up in value. In both of these situation you don’t have to put your most valuable resource, time, into earning more income.
For example, if you purchased a home in 2020 for $900,000 and in 2021 it’s valued at $1,000,000 – congratulations! You just earned $100,000 without having to put your personal time into earning it.
This is how wealth works and why wealth accumulation is important to achieving financial security.
Taxing Income vs. Capital
In addition to wealth accumulating over time, property that contributes to net worth tends to receive preferable tax treatment compared to income.
When you earn an income you will pay income taxes on the amount you earn. You will pay income tax rates at both the federal and provincial level at rates prescribed by each level of government.
When you accumulate wealth you only pay taxes when you dispose of that wealth and only if there was a gain. This is called the capital gains tax. Property that has the ability to generate income is referred to as “capital”. Capital property includes things such as shares in a company and real property.
Capital gains tax is preferential because only a portion of the gain that you earned is included in your taxable income (as opposed to nearly all of the income you earn from wages or salary).
So if you earned $100,000 when you sold your shares, only 50% of the gain would be included in your income (this is called the “inclusion rate”). So only $50,000 of that $100,000 gain would actually be taxable. This amount is then taxed at your marginal income tax rate.
The inclusion rate is subject to vary with the government in power. It has been as high as 75% in the debt crisis of the 90’s but typically settles in around 50%, which is where it is now in 2021.
While the example I provided above is very simplified it shows how wealth is preferable method of accumulation for financial security.
Median Income and Net Worth by Age in Canada
So how do you stack up in terms of income/wealth against your peers?
I’ve compiled some data from Statistics Canada about the median wage/salary and net worth for various age groups across Canada.
Conclusion:
As you can see – income and wealth are similar but different concepts and it’s important to understand the difference between the two. Income makes it possible for you to accumulate wealth – the gold standard by which financial security is measured.
How do you compare? Have you been able to build your net worth over the years? What’s your biggest challenge to building net worth?