How to get rich
Step 1: have enough money to buy assets
It's just that easy
this post was submitted on 14 Jan 2024
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I think you accidentally wrote rich dad poor dad
I was born with an asset, but it's got a huge crack in it.
Well that's one way to become wealthy, just shake that asset yo momma gave ya!
:P
This is why billionaire defenders who say people like Musk and Bezos aren't really that rich because they have little liquid funds and they can't sell stock are bullshit. They have nearly infinite money with these loans us normal people can't get. The closest thing we have are mortgages against the only thing of value many people own.
Loans are not taxable income is something that got left out. So you take out loans at interest rates lower than taxes. But yeah, this is all correct. We got offered a ridiculously low rate loan against our retirement funds, might as well have been zero, with no due date. Just a constantly revolving line of credit. Didn’t take it.
Why not?
Because it was tied to the stocks they wanted you to invest in. As long as the stock was up, you could borrow up to the amount the stock was worth. However, if you borrowed say 60% of the value, and the stock tanked 60% you immediately owed the 20%. It was in the lead-up to COVID, so we didn’t bite thinking things were gonna be really volatile.
Dodged a pretty serious one. Holy damn.
Yeah, sorta…. The responsible thing would be to not take out more than you can afford to pay back quickly, and if we were well off with good cash reserves then this sort of scheme would work out great. You would get a super cheap loan and skip out on a lot of tax. However, we’re pretty average and like most people don’t have cash laying around at all, so this seemed like a risky prospect. It wasn’t for us. But you can see that for a wealthy person this would work pretty well.
I feel like I'm too poor to understand what happens between steps 2 & 3 without having a job. How are they paying the loans off? Where does that money come from? And if they have an income in order to pay the loan, why get the loan to begin with?
The investment assets can be assumed to appreciate at, say, 7% (reasonably accurate historical US stock market performance). The loan is at a lower interest rate (let's say 3%, which is a number I just pulled out of my ass).
So what they do is take out a loan secured against their investments (which is why it doesn't require having an income to get approved), get a huge lump sum of cash and put that in their bank account. They make payments on the loan by drawing down that lump sum (along with their living expenses or whatever else they want to use the money for). Since the interest rate is >0%, obviously they would run out of money before paying the loan back, right? Well, that's the trick: by the time that happens, their assets have appreciated enough to have enough collateral to get another loan, so they rinse and repeat.
Note that the last line ("assets have appreciated enough to have enough collateral to get another loan") implies that these loans are relatively small compared to the assets backing them. I'm not going to bother doing any actual math, but basically this strategy only works if the expenses you want to cover are some single-digit percentage of your asset value. In other words, if you wanted to borrow $50k/year, you would need more than $1M in assets.
You do this loan thing instead of just living off the dividends because withdrawing the dividends from your investment account incurs capital gains taxes, while getting a loan doesn't.
So they just pull loans in succession, each time large enough to pay the remainder of the prior loan. Meanwhile the assets continue to appreciate, giving more security against the also increasing (but slower) loans.
When does the loan train eventually stop and get paid up? Death doesn't usually wipe them out, but I guess liquidate just enough to pay the debt and the remainder goes to inheritance?
Why pay the remainder of the previous loan? Let those go to maturity.
And yes, the loan train ends at death, and assets are sold to pay them. But since they're dead, they don't pay capital gains on it, the basis (original value of the investments) is stepped up to the current value and the total amount is hit with inheritance taxes, which are usually a lot lower than the income or capital gains tax rate they would otherwise have (income taxes would be 20% for capital gains and 30+% for regular income tax):
Rates typically begin in the single digits and rise to between 15% and 18%.
The "tax writeoff" is a reduction in the taxable basis for the inheritance. So some quick math:.
- assets worth $100M, $50M subject to 20% capital gains tax
- loans for $10M
- inheritance tax - 18% (top end)
If they paid these off the day before they die, it would cost 20% of $5M, or $1M, and then 18% on the other $90M ($16.2M), for total taxes of $17.2M (heirs inherit $73.8M). If they wait until they die, it's 18% of $90M, so they avoid the capital gains tax entirely, so the total inherited amount is ~$74.8M. The difference is probably bigger since that 18% is the top rate and depends on who is inheriting.
I hope that makes sense.
The system really is rigged by the rich to keep them getting richer. That's wild, thank you!
Yup, that's what's called a loophole. If we just set inheritance taxes to the same as capital gains rates, the loophole would effectively be closed.
Well yeah. Of course the people making the laws are going to write them in their favor.
Wouldn't they need to pay the full loan by maturity date? Or are they getting loans with no maturity date?
No, they pay the loan balance throughout the term of the loan. For example, for my mortgage, my final payment is the same as every other payment, it's just the point as which my debt reaches $0.
However, they're probably getting margin loans, which have no maturity date. With a margin loan, you just pay interest in the loan, with nothing going to principle, so they'd just keep that same loan until they die (rates change with the market).
It's probably a mix of both.
Great explanation.
I was surprised that the loan is paid back after the assets get the stepped up basis, and not at the original basis.
Yup, estate tax uses stepped up basis, and fed tax is taken out first, so every other debt will use the post-tax amount.
Fun fact to compare to stock market.
The housing market in Vancouver BC has appreciated at an average return of more than 15% every year for the last nearly 30 years.
Where are you getting a loan for 3% while the stock market is performing at 7%? I always see these arguments, but borrowed interest is almost never lower than gains. That's why step 2 of any worthwhile financial plan is always "pay off your credit cards and high interest loans", right after "save enough for an emergency fund". "Invest your money" doesn't come until a few steps later.
Banks will happily take 3% risk free from someone sufficiently wealthy given the associated relationship benefits: a multi-millionaire or billionaire is probably going to hire that bank for wealth management and pay fees, etc, etc.
I'll have to take your word for it, I guess. It'll be a long time before I have a million dollars cash.
That's true for most folks, and is why it's so hard for people who aren't ultra wealthy to understand just how different the world is when you have that kind of wealth; a world where the law and the financial system and the basic experience of the economy is completely and utterly different due to the power and influence that wealth brings.
Heck, most people can't even truly grok the scale of the difference between an average person and a multi-millionaire or billionaire. The human brain just doesn't process large numbers like that well.
I'm far from rich, but I do have a paid off house in a low CoL area, and a have decent chunk of retirement savings put away, and even then I get different treatment: better credit cards, better loan products, etc. The industry calls it "qualifying" but what it really is is monetary gatekeeping.
It's particularly weird having grown up relatively poor because I've lived the shift and can see how expensive it was to be poor, and how relatively easy it is for the rich to get richer.
¯\_(ツ)_/¯ Presumably billionaires get offered exceptionally favorable terms that aren't available to the general public, I guess?
Yeah this is definitely missing a step somewhere. The loans have to be paid off even if you're dead. Before your kids get anything your assets are used to pay off your debts. Unless there's a loophole in there where the kids can assume the debts and somehow get the assets tax free, then this post doesn't make sense.
**Edit: Ah ok the loophole is in allowing the heirs to use step up basis when inheriting the assets. The whole lifetime gains on the assets goes untaxed.
Yeah that's a big loophole.
Debts will also only get paid out of their estate and never transferred on to kids or family unless it is using a joint account or the inheritors explicitly accept it. If they transfer the assets before they die, then die with 0 assets and a ton of debt, the debt just disappears (as far as their family is concerned).
Unless I am understanding that loophole wrong.
The current loan gets rolled into the next loan and becomes a revolving door of credit. As long as you don't spend faster than the assets appreciate you'll always end up ahead.
Hypothetical: Assets like land and housing are reliably expected to only increase in value.
Once one loan runs out, the assets are worth more and a new loan will be potentially considerably more than the previous.
As a second hypothesis, I suspect that fractional reserve banking plays heavily into this.
I don't think fractional reserve banking is necessary here. Fractional reserve banking just makes it easier for banks to make loans, it has little to do with rich people taking advantage of tax law.
For example, the most obvious loan is a margin loan, which doesn't require any fractional reserve banking whatsoever. Quite often brokerages will offer margin loans backed by the assets themselves and force you to sell if you go under a certain loan to value limit, which means the risk is incredibly low. Banks will then use the loans as a replacement for savings accounts to earn reliable interest on cash assets, so it doesn't need to be tied to reserve rates. However, if reserve rates are lower, they'd probably take advantage.
In fractional reserve banking, banks make loans with deposits, and they make more loans using those loans as assets, and federal rules stipulate that they need you have a certain percentage of the loan values liquid (i.e. so depositors don't lose their money). With margin loans, they don't use savings deposits to make loans (there are no savings deposits, everything is invested in a fund), they instead use brokerage assets. So there's no fractional reserve system at all because the only ones impacted are the brokerage themselves.
you take out more loans. as long as the interest you pay is lower than the gains you're making in the stock market or wherever, you're ahead and not paying taxes.
This is all good and well, until a 2008 happens. That's why strategies like this are only reliable if you have generational wealth to start with. You have to be able to withstand massive risk.
Massive is relative. If you have $1M and need $40k to live on (4% rule), a 50% downturn is massive. If you have $10M and need $100k to live on, a 50% downturn still leaves you plenty of room.
You don't need generational wealth, you just need a enough that the general "rule of thumb" is way more than you'd ever need to spend. That can be amassed in one generation.
I was thinking that too. Works as long as asset appreciation > interest.
We're in a higher interest rate world with a recession on the horizon, so this strategy may not work moving forward
Only mortgage interest is tax deductible and there's a cap. You can't just deduct whatever you want. The big win is most "income" is long term capital gains, which isntaxed at a lower rate.
Yeah the tweet really showing how clueless they are there.
He got the details wrong, but the important part right. They live off of loans and either let the interest ride or only sell enough assets to pay the interest. When they die, their heirs can sell as much as is needed to pay the loan tax free because the basis is reset to the current value of the assets when they are inherited.
This isn't the only thing they do, but it is one part of it
This is why we need a wealth tax. Anything over 10 million, 5%. Every year!
They forgot Step 0: Make Tax Free Income.
Estate tax only starts at 13 million, but a shit ton of poor Republicans are worried about it....
It's amazing how many Republican voters foam at the mouth about inheritance taxes when it won't ever affect them or anyone they know. Temporarily embarrassed 14-millionaires.
It's one of the few taxes that I think are completely valid. When you're dead, you don't need your income anymore, so there's really no negative impact to you. Yeah, it impacts your heirs, but you can provide for them in other ways, like paying for their education, giving them gifts while you're alive, etc.
Let's not act like they don't get anything, it's just taxed.
Yup, and current rates are quite reasonable.
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