Is ‘Lifestyle Creep’ killing your wealth?

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Do you recognise this in your budget?

Lifestyle creep a hidden effect, especially in higher inflation environments like ours. Basically, it is the continuous upgrading of one’s lifestyle and increases in consumption in REAL terms as our incomes increase. I have capitalised REAL for a very good reason, it is the actual increase minus inflation. In other words if your increase is 6% and inflation is 6% then the real growth is zero. When it comes to after-tax income though, it may even be negative. This is usually a problem when it comes to the big lifestyle expenses, like houses and cars. I have gone into the wealth implications of both these purchases HERE, so I am not going to repeat myself, but if you ‘upgraded’ your house or car because you’ve received an increase or promotion, then read on…

What has tax got to do with it?

Tax is levied on a sliding scale in groups called “Income brackets”, have a look at the graph below which is for the 2017/2081 tax year.
2019

Let’s look at the middle of the range of income tax bracket, which is where most of the lifestyle creep occurs: In the tax year ending 2016 the range was R393201 – R550100 the marginal rate was 36%, in the year ending 2017 it was R406401 – R550100 and this year ending Feb 2018 it is R410,001 – R556000 tax rate 36%. it’s all 36% so there will be no tax rise? Not so fast…

In 2017 this translates into a 3.35% movement in the bracket when inflation was around 6% and 2018 it was even worse, with a minuscule 0.88% movement when inflation was around 6%. In other words, the government is deliberately pushing your income into a higher tax bracket every year. In effect, therefore, in the 2016/17 tax year, unless you had an increase above 9.35% you had no real increase in take home pay. In 2017/18 it would have to be over 12% to have a REAL increase in take-home pay. If you feel that you’re poorer, that is why.

Cutting consumption is the least palatable (but essential way to free up discretionary income). If you’ve been misled by these imaginary increases and are in a hole, stop digging. Selling a house that is beyond your means is smart. Sure, this is drastic and probably goes against everything you’ve heard over the years, so let’s have a look at that in more detail. You could move into something smaller and cheaper – then rent your home out – but what if your tenants default? Can you pay rent and the bond for up to 2 years (it can take that long to evict a defaulting tenant so you can’t move in any way) ? If you want to have a rental property portfolio then I recommend you have at least 5-6 properties to mitigate this risk – or be in a position that you can afford to carry its costs for at least 2 years). Sure, all those transfer costs etc will be down the drain – but they are there anyway, they do not increase the value of your house. Your home is not an investment, it is a lifestyle expense that replaces rent, and if you pay it off, replaces the need to rent later in life. Your mortgage has two components – the interest and capital repayments – your monthly statements from the bank should show this clearly. The ‘interest’ is the rent, the capital is the actual investment (that will enable you to live ‘rent free’ once it is paid off.) Long term (decades), house prices have been increasing at about 6%, in the new normal post 2007 though the returns have been lackluster at best (as you can see from the graph below) – you’d have got better returns from the money market ( without all the other expenses like insurance, transfer costs, estate agents commission etc). What does all of this mean – owning a house now is not necessary to grow your wealth.

Your mortgage has two components – the interest and capital repayments – your monthly statements from the bank should show this clearly. The ‘interest’ is the ‘rent’, the capital is the actual investment (that will enable you to live ‘rent free’ once it is paid off.) Long term (in other words over decades), house prices have been increasing at about 6%, in the new normal post 2007 though the returns have been lackluster at best (as you can see from the graph below) – you’d have got better returns from the money market (without all the other expenses like insurance, transfer costs, estate agents commission etc) even taking tax into consideration. What does all of this mean? – Owning a house now is not necessary to grow your wealth and could in fact set you back years.house

Unless you’ve had a great promotion or changed jobs (often the only way to get a decent salary increase) then the government is making you poorer every year. This week RSA Inc went into a ‘technical’ recession (2 quarters of negative growth) so it is more likely that you have had little or no salary increase in a while – perhaps just thankful to have a job. In addition to this “Income Tax Bracket Creep” there is, of course, all the other stealth taxes like increased fuel tax (now making up 50% of the price, VAT, sin tax, CGT etc. Over the last few years, the removal of the Income Protection policy premium deduction and the ‘tax credit’ status for medical aids has eroded it more. The bad news (as if that wasn’t bad enough) is that this insidious increase in taxation is expected to continue for at least the next couple of years as SARS battles to keep up with filling the black hole of government spending. Some estimations are that they will have an R45bn deficit this financial year. The good news is that interest rates don’t look like they are going to rise this year, and they may even decrease. If the interest rates rise, people who have been fooled by this lifestyle creep are going to find it really hard. Always factor a 50% increase in interest rates before taking out a mortgage. Increases of this magnitude or more has happened more than once in my adult life.

What can we do about it? The most obvious solution is to increase your income – get a ‘side gig’ if you’re a salary earner – obviously on your own time. Some companies prohibit this in the employment contract so read yours first, and if possible get a ‘variance’. Perhaps you are in a career that can be freelanced? Working for yourself gives you much more leeway when it comes to tax deductions (at the price of less job security perhaps). If your job is under threat from retrenchment, why not negotiate a freelance contract? Many companies would jump at this opportunity because it reduces their liability and the expenses don’t appear as a ‘personnel cost’. If you do freelance, I recommend that you allow the companies to continue to deduct PAYE and submit to SARS – it takes considerable discipline to save for tax at a level of 20-35% of your pay.If you don’t get a PAYE deduction you will have to become a provisional taxpayer, but your accountant can go through that with you.

Action: Minimise your debt, live within your means, be realistic about your actual take home pay and don’t bite off more than you can chew when it comes to a mortgage or car repayments.

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