In our PF/FIRE blogosphere, we all like to talk a lot about saving money and about reevaluating our priorities to need and buy less. This is life-changing stuff we’re talking about, but even still — an outsider reading some of our community’s stuff for the first time could be forgiven for thinking that we’re all a bunch of low-income earners trying to figure out how to stretch our meager dollars.
But, there are some super important times when it’s actually better to drop this low-income, super-optimized, super-frugal mindset and think like rich people, even if we never intend to spend money like some of them do. Because if you’re aiming for FIRE, at some point you do actually become a rich person. (Not to mention that anyone in the U.S. earning more than $32,000 a year is already in the global 1 percent — we’re practically all rich!)
This isn’t a post about buying a Bentley and hiring a butler. Instead, it’s about acknowledging there are different risks and opportunities when you have a high net worth, and it’s important to take certain steps in recognition of that.
Thinking Like a Rich Person
A big part of thinking like a rich person is simply acknowledging reality, which sometimes means recognizing that money has a way of bringing out the worst in people. Having a high net worth opens up new opportunities, but it also makes you a target.
FIers are a paradox: the paradox of the couple/person/family who’s both rich and poor. (Asset rich, income poor.)
Though so much of our financial life now is retraining ourselves to think like versions of ourselves with a much smaller income (income poor), to prepare for when our income really will be small in retirement, in other ways, we’re having to retrain ourselves to think like rich people (asset rich).
Here’s how we’re shifting our thinking:
Acknowledging you’re a target — When you have a high net worth, you’re more likely to be sued. And it could be for whole range of things that aren’t your fault: A contractor in your home subs out some of the work to an unbonded trade person who gets hurt while working for you. A friend attends a party at your home and then gets in a drunk driving accident on the way home. A girl scout selling cookies trips and falls on your front steps. For someone with many millions in the bank, these types of lawsuits don’t pose an existential threat (but still enough of one to put safeguards in place), but most of us aiming for FIRE aren’t building in a $5 million cushion. A single suit with all its legal fees could wipe us out, even if we win.
What a rich person does: Buy umbrella insurance. Umbrella insurance provides additional liability coverage above and beyond what you have from your auto/health/homeowners insurance to protect your assets. And it’s pretty affordable, too — we got a quote from USAA for $17 a month for $1 million in coverage (the lowest option), $28 a month for $2 million. (We do not have $2 million dollar sitting around — we were just curious.) Every major insurer offers this coverage, though many only offer it if they also insure your car and home. If you own your home, you may also wish to declare it a homestead, which some states allow. This helps protect some or all of its value in the case of lawsuit or bankruptcy. [Update: We just purchased the USAA umbrella policy. It also required increasing the liability limits on our auto and homeowners policies to $300,000, so in total our premiums are increasing just under $40 a month all in.]
Managing taxes — We’ve all heard the quote that Warren Buffett pays a lower tax rate than his secretary. And tax law in the U.S. anyway already favors the wealthy in some key ways, not the least of which is the much lower tax rate on long-term capital gains than on earned income. But as we’ve learned as our incomes have gone up, this fun little thing called the alternative minimum tax (AMT) also starts kicking in at a certain point, which chips away at your legit deductions and starts adding extra tax on top of it all. It’s for a good cause — to make sure top earners don’t use loopholes to get out of paying taxes — but it can add thousands of dollars of tax liability each year, which could make or break your FI plan.
What a rich person does: Start a shell corporation in Panama — kidding! While there are plenty of legal tax-avoidance strategies available to people with major big bucks, the more accessible and ethically less questionable approach is to control when you realize certain income. This is the idea behind 401(k)s and IRAs — you earn income now, but don’t pay tax on it until you intend to spend that money. Many of us who are retiring early are already maxing out these vehicles, which should reduce how much we pay in total taxes over time. But if you’re not, no better time to start than today! For early retirees, controlling when you realize income also means having the flexibility to decide when to do things like backdoor Roth conversions, to ensure that you’re not jumping up a tax bracket or losing a valuable Obamacare subsidy tier. (Go Curry Cracker has a good breakdown on that here.) Or you might consider doing a little tax loss harvesting, something we don’t do but we know lots of y’all do. Or even starting an LLC or S-Corp for business purposes, like managing a rental property. There are lots of options available to reduce your taxes if you are willing to do a little research.
Ensure your estate is distributed as you intend — While estate planning is important for everyone (and we did a full breakdown on ours here), a high-value estate is certainly more consequential than, say, a $50,000 estate. Without proper planning — a legally valid will, for starters — your assets could end up anywhere when you die. Or, worse, those left behind could end up fighting over all of it. Even very decent human beings can behave quite badly to one another when it’s over a sizeable sum of cash, like a large inheritance, and the last thing you want to do is have your passing drive a wedge between loved ones. You may also wish to leave a large bequest to charity — we know we do.. Even with a will in place, the disposition of most high-value estates still ends up in probate court, a long, expensive, bureaucratic process.
What a rich person does: Put in place a comprehensive estate plan and trust. Most high net-worth individuals have not only a detailed will in place, along with the medical side of things (advance directive, durable health care power of attorney, last wishes), but also some form of legal trust. The most basic, the revocable living trust, allows your estate to stay out of probate and reduces the threat of legal challenges against your estate. We haven’t set one of these up yet, but it’s on our list.
Considering alternate investments — High net worth individuals have asset allocation that looks different from what the rest of us have. The super rich, for example, have access to private equity and hedge fund investments, which aren’t available to most people publicly. But that doesn’t mean that we can’t all think differently about how to diversify our portfolios.
What a rich person does: Look for other ways to make assets work for them. In addition to buying the standard stock funds and bond funds, a lot of aspiring FIers have gotten into the Lending Club assortment of private lending, and we have made a personal loan that’s giving us a solid rate of return. Venturing into lending is an inherently more risky proposition than basic investing, so it’s worth doing lots of research, but it can be a great way to diversify and get some better rates of return, especially when markets are flat. Leveraging assets to increase earning could also include things like renting out your home on Airbnb.
[Update: We also think a spirit of generosity is a hugely important part of thinking like a rich person — and just being happy generally — and have a post about that coming soon!]
How do you think like a rich person?
Some of this stuff is a big shift for a lot of us, especially after we’ve spent a lot of time changing our mindsets to focus on less and enough. But not acknowledging that we have significant assets saved up can be an even more costly mistake than overspending. What do you do in your financial life to protect yourself and your family? We’d love to hear more ideas!