Death of the Middle Class

The middle class will be executed in the near future by four horsemen:

1) Taxes

2) Inflation

3) Bad Debt

4) and the old 401k

Taxes

If you work for a paycheck you are earning earned income which is taxed at the highest level, up to 50%. There are three types of income:

• Earned
• Portfolio
• Passive

Portfolio income is taxed at 15 to 20% and passive income is potentially taxed at zero percent. Portfolio income is created through capital gains and dividend paying stocks and passive income is generated through investments such as rental property and business. Business owner's utilize tax deductions to lower their taxable income.

An example of zero percent money:

Let's say you buy a $100,000 property with a 20% down payment and a principle balance of $80,000. After five years, through improvements to the property and appreciation, the property is now worth $150,000. The bank will give you up to 80% equity in a new loan. So after five years, you have $76,537 equity in the property:

• You have paid down the original mortgage to $73,463

• The value of the property is now $150,000

• $150,000 – $73,463 = $76,537

Thus, the bank will give you $61,230 ... tax free! Of course this would have ramifications to your cash flow and you may want to consider taking out only 50% of the equity which would still be $38,268.50. Remember, this tax free money equates to $76,537 in earned income since by the time all is said and done, earned income is taxed at 50%. This is one of the reasons why debtors are winners and savers are losers in this new economy.

Additionally, earned income could possibly be taxed at higher levels to cover social security benefits. At Social Security's inception there were approximately 16 workers for every retiree. Soon that number will be down to 3 to 1 and one of the solutions is to tax more heavily those still working.

Inflation

Inflation is the silent tax and essentially it can be thought of like this: You go to your local food super-mart and buy a box of Kellogg's Corn Flakes for $3.50. Two years later you go to the same food super-emporium and buy the same box of Corn Flakes for $5.00. You have experienced inflation.

In Germany in 1923 they had 33 printing plants cranking out 45 billion marks a day in order to counter their deflationary economy. A pair of shoes that used to cost 12 marks cost 30 trillion marks. A loaf of bread went from half a mark to 200 billion marks. In the U.S. it took us 200 years to go from a currency supply of $0 to $825 billion and then last year ... we printed another $900 billion and then another $1.2 trillion. So now we are at $3 trillion dollars. Add this to our fractional lending system (for every $1 you put in the bank they can lend out $9) and the result is a heavily diluted money supply. Your dollar competing with trillions of other dollars means your dollar becomes worth-less, thus inflation.

Additionally, stock market talking heads (the ones who say invest your money in the stock market, close your eyes, go to sleep for 40 years, wake up and see how much you have) claim that on average the stock market goes up by 10 to 11% over the long haul. When you put the Dow in terms of real value, (not dollars, but real value) this is the picture you get:

The market has been crashing for some time.

Good inflation fighters: fixed rate debt, real estate, gold and silver.

Bad Debt

If you buy 5 jet skis on credit cards, you have just created bad debt at a high interest rate. Let's say you pay $25,000 for the jet skis. In two years they are worth half as much but more than likely, with interest payments you still owe what you bought them for. Essentially they are now worth $12,000 but you still owe $25,000. You are upside down on jet skis by $13,000 and this scenario is the black hole of the middle class. Plasma TVs, expensive cars, boats, home entertainment systems all fall into this category. If you want nice things first buy assets that cover the expense with cash flow.

The Old 401k

The trick with the old 401k is that it comes right off the top of your paycheck and when you withdraw the money at retirement it is, taxed at earned income levels. Additionally, you are typically investing in a vehicle that has been crashing for sometime and faces a new threat: the flaw of ERISA.

With the passage of the ERISA act in the 70s, companies switched from a defined benefit plan (pensions) to defined contribution plans (401k and IRAs). This switch was a significant savings for employers - they no longer had to fund your retirement - but there is a fundamental flaw to the program and it originates with baby boomer population numbers. A staggering 65 million baby boomers will hit retirement age in the next few years and there is not an upcoming generation to replace their ranks (we had a birth dirth in the 70s and 80s.) In the near future millions of baby boomers will be required to start withdrawing funds from their defined contribution 401ks and IRAs. This is not optional - this a mandated minimum withdrawal. When folks withdraw from their stock accounts they place sell orders. When the market is sold the market drops.

Additionally, when you invest with a mutual fund you pay a management expense fee. Although it can appear to be misleadingly low (1%) the mutual fund management team actually rakes in up to 80% of your profits. So in this investment you are putting up 100% of the investment, taking 100% of the risk and only get to keep 20% of the profits. In the end it is a Vegas casino in which the house always wins.

In the end, the four horsemen of Taxes, Inflation, Bad Debt and 401k savings will annihilate the middle class - you will either be rich or poor with nothing in between. To combat these threats you must develop a good financial IQ, learn about different types of investments such as business and real estate, and change your context.