Educational Spotlight: What Can I Do With My Income?
We are blessed with (too) many options for income that we receive, but these choices can be categorized into four broad categories: taxes, giving, living and saving. Taxes are a natural consequence of living in a civilized society and having income or assets.
Taxes may feel inevitable, but there is plenty we can do to reduce our taxes, including contributing to a retirement plan, moving to a lower tax jurisdiction, investing in a tax-efficient manner, and engaging in activities for which the government offers tax breaks. Money saved on taxes can be applied to one of the other three categories, but tax reduction should be a means to an end and not an end in itself. Engaging in otherwise non-economic behavior to earn a tax advantage may not be wise. Tax preparers generally encourage tax deferral, as paying money later is often preferable to paying money today, but this is not always the case. Decisions undertaken for tax benefits should be considered in the context of a broader tax strategy that looks ahead throughout the taxpayer's life. Finally, we can minimize taxes by simply not having any income, but this is clearly not optimal. Rather than minimizing taxes, we should think about optimizing taxes. This may mean accelerating income when a taxpayer is in a low bracket to avoid getting taxed at higher rates later.
Giving is optional, unlike taxes, but it is an income allocation category that should be taken seriously. It is probably the most neglected category. People of faith believe that giving pleases God, who gives us everything we have, and brings us into His work of blessing others. Even those who aren’t convinced of a personal God who seeks a relationship with them, giving offers many benefits. It breaks the grip that fear, greed and our possessions can have on us. It helps us to appreciate the things that we have. It reminds us of our place in the world and our ability to make a difference. Finally, it can bring much more contentment than buying one more thing or gaining one more experience. When I talk to generous people, I notice they tend to be content, even if they live a modest lifestyle. They do not express regret over what they have done to help others or wish they had spent more on themselves.
Spending, or living expenses are a mix of necessary, and optional. For those of us in the West, most of what we spend is discretionary. Even our food includes delicious items that we want and not just the minimum to keep us from starving to death. We can spend to meet our needs, spend to enjoy ourselves or spend to impress others. We live in a beautiful world, full of places to explore, activities to engage in, and delicious foods to eat. Unfortunately, we tend not to spend very wisely. We are impressed with things we think we want, many of which fail to live up to our expectations. We see others enjoying a certain lifestyle, unaware of what trade-offs they may be making to have what they do. Of course, there is a multi-billion dollar advertising industry dedicated to make us want what we do not already have. In his excellent book, “The Psychology of Money”, Morgan Housel observes the differences in how people spend versus what makes people happy. He recommends prioritizing experiences with other people over acquiring things, avoiding purchases solely to impress others, and living close to work, among other things.
Saving is the only category that does not prevent us from using the same money in another category. Spending can’t be unspent. Giving can’t be ungiven, and good luck getting the government to reduce taxes already paid. Savings prepares us for the future, utilizing the ability God gave us to plan ahead. It allows us flexibility in spending and giving. Savings can even be invested to grow and provide for more giving and savings, and yes, probably more taxes. Money saved can be used in different ways, and the best place for savings depends on a person’s individual situation. Debt retirement reduces a repayment obligation and also lowers the cost of living by reducing interest expense. Investments can generate a return, allowing savings to grow more quickly. Investments can generally still be accessed if needed, though possibly at a cost. Retirement savings can reduce taxes, now or in the future. Cash savings maintain flexibility. Saving gives some great benefits. Perhaps the best is the peace of mind that comes with being prepared for the unknown. Life happens. Unexpected “one-time” expenses are all too common. Money saved up can be the difference between a crisis and a disappointment. Another great benefit of savings is optionality. Sometimes positive opportunities are presented. Having savings allows us to take advantage of these. Finally, there is independence. Even the most work-loving people will likely not be able to work their entire life. Life expectancy has increased, and people can live decades after their paycheck stops. Saving money while we are earning it, and then prudently investing those savings allows us to continue to take care of our needs once the paycheck stops.
Like any paradigm, the taxes, giving, living and saving model is a generally useful way of looking at where our money goes. There are a few ways we can spend that may blur the lines. Is a donation that secures some benefit like the right to purchase season tickets, spending or giving? What about home improvement projects that increase the value of our home? Some discretion can be used, but we should guard against rationalization, which is a sneaky enemy. Sales professionals know that phrasing a purchase as an “investment” decreases resistance.
If we plan proactively, we can try to divide our resources well among these four categories. Without adequate planning, we will probably spend too much, pay too much in taxes and not save and give enough.
 Some people would add debt payments as a fifth category, but this truly is a sub-category of savings. Whether we use an incremental dollar to put in our bank account, add to our investment account or pay down debt, if we have not used that dollar for spending, had it taxed away from us or given it away, we have increased our net worth by $1.
 It is true that we can sell something we bought, but this usually entails some loss of value.