What Would it Take to Stay in the 1% of Earners Perpetually?

In Canada, the top 1% of earners in 2010 made $201,400. Coming from America with the biased belief that financial systems are structured to keep the rich financially well off, I wondered exactly how much (or little depending on your viewpoint) money it would take to perpetually make the equivalent of $201,400 off of investments.

In other words, how much do you need invested to become a Trust Fund Baby? You would think you could live rather comfortably if you just eked your way into the top 1% of earners in Canada, so it seems like something that would be nice to reach. It would also suggest that if you have more than the amount required you could consider doing what Warren Buffett does and donate more to charity.

First thing is to calculate an actual net income from that gross income since earned income is taxed at a different rate than capital gains. Canada has both federal and provincial income tax rates, so it can vary from province to province. Using a tax calculator from Ernest & Young, I’m going to focus on British Columbia since:

  1. I would be happy living in Vancouver
  2. It’s the top line in the calculator so it’s easier to follow.

That means someone who made $201,400 entirely from earned income would bring home $133,315. Yes, this is a gross simplification as there could be stock, bonuses, and various other things not taxed at the same rate as earned income, but this is a blog post I’m writing for fun so I want quick and simple.

Now that we know our goal is to receive $133,315 annually from our investments, we need to know what has to be earned in gross income from our investments. Once again, to keep things simple I'm going to ignore dividends and such and just assume all money is made from selling stock and thus capital gains. According to the Ernst & Young tax calculator we used earlier, the tax rate on capital gains is 21.85% in BC (this is because in Canada the tax rate is applied to 50% of the total capital gains at the highest tax bracket you reached). This means our investments must earn $177,754 to give us $133,315 after taxes.

How much should we expect from our investments? I've heard the rule of thumb that about a 7% return is reasonable to expect. That would mean we need to invest $2,539,343 and make 7% forever. Now obviously the market fluctuates so some years will be good and others will be bad, but amortized over your lifetime it should (hopefully) work out. If you want to be conservative and only assume 5% then you need to invest $3,555,080 which is an increase of $1,015,737 over the 7% goal/hope.

OK, so let’s go with the lower number of $2,539,343 with a 7% rate of return to at least make this silly goal seem easier to achieve. How the heck could you end up with that amount invested, starting from scratch? Assuming that 7% is consistent, how much would you need to put away each year at some time frame to reach this lofty goal of never having to work again while still being in the 1%?

Playing with a compound interest calculator it seems you could reach that amount of money in 30 years (which is about how long I have until I should expect to retire at the moment) with a monthly deposit of $2,200 with 7% interest compounded annually. If you push the horizon out to 40 years (more along my wife’s timeframe) it drops the monthly investment requirement to $1050/month. Even if $1050/month made up 10% of your monthly net income you would need to bring home $10,500/month net which is $180,000/year gross income.

In other words to make this in any way achievable for the average person to reach in their lifetime they need to be making $180,000/year starting at age 25 in order to simply retire in the top 1%. Obviously most people don't reach that kind of income that early in their lives nor have the discipline to save 10% of their net income every month for 40 years. Obviously your savings rate can grow as you earn more, but still, we are talking amounts of money that most people never reach.

This is why becoming rich enough to live off of your investments is tough. The amounts required, the discipline needed, and over such long time scales are not easy to meet in the slightest. This is why it typically take a bit of luck to reach this level of wealth in the world. Or rich parents.