Income: A Four Letter Word

The word “income” should be outlawed. Or if not outlawed, at least treated with same disdain and awkward silence that might greet an ethnic slur or the word “groovy.”

“Income” means so many different things—some precise, some vague and ill-defined—that its use can’t help but engender miscommunication. You mean one thing when you say “income,” I take it as something completely different, and—presto—miscommunication.

Or worse, even within the quiet confines of your own mind, using an ill-defined concept of “income” can lead to the capital crime of sloppy thinking.

Consider all the different meanings of income. Imagine you have a $5,000,000 pot of assets to retire on. Pretty nice thought, eh? You could live quite comfortably off that. Let’s say you decide to use the 4% Plan as described in January 13’s post (which I don’t particularly care for, but at least the arithmetic’s easy). So you pull out $200,000 to spend. What is your income?
• If that $5,000,000 is in a traditional IRA, and you take a $200,000 distribution, your tax accountant would say you have $200,000 of income. She’s thinking taxes and gross income.
• If you tell your accountant you have made $100,000 of non-deductible contributions to the IRA, she might say you have $196,000 of income. She's still thinking taxes, but now she’s thinking taxable income.
• If instead that $5,000,000 is in a trust Grandma left you, and the trust’s investments yielded, say, $100,000 of interest and dividends, your trustee would say you’ve gotten $100,000 of income and $100,000 of principal. He’s thinking traditional accounting income.
• If the trustee was a bit more modern, and applied his newfangled powers to redefine trust income, he might instead say that the entire $200,000 is income. He’s thinking modern trust accounting income.
• If you’ve decided to spend $200,000 because that’s the largest annual amount you think the pot will sustain for your whole lifetime, you might think that $200,000 is your income. You’re thinking of sustainable spending as income.
• If the $5,000,000 is in a managed investment account, which grew $400,000 in value during the year (not 2008 obviously), your investment advisor might say you had $400,000 of income, irrespective of how much you have chosen to spend. He’s thinking of investment performance as income.
• If, to get your allowance converted to cash, you had to sell $200,000 of appreciated stocks originally costing $50,000, your accountant might say you’ve got $150,000 of income. Again, being tax-oriented, she’s thinking of realized capital gain as income.
• If you took the whole $5,000,000 and bought an annuity paying you $300,000 per year for life, your insurance agent might say you’ve got $300,000 of income. She’s thinking of the annual annuity amount as income.

Eight different meanings of income, all valid within the appropriate context. But what really counts? Ask your grocer or your mortgage lender or your cable company. They just want to be paid in cash. They don’t care whether it’s income in any sense of the word. Really, income just doesn’t matter.