Terms like "rich" and "wealthy" are used to describe financially prosperous individuals, but there is no exact definition as to what makes a person rich or wealthy. Total earnings and net worth are two common measures of financial prosperity. Earnings describe the total amount of money you make, while net worth describes the total amount of money you already have.
Earned income is the money you make from working a job, performing contract labor or running a business. Income that doesn't require active work like capital gains on investments, interest, dividends, unemployment benefits and Social Security is technically "unearned income." Defined narrowly, total earnings are the sum of all your earned income over a certain period of time. Defined broadly, total earnings can describe your total income from any source, whether earned or unearned.
Net worth is a common measure of wealth equal to the sum of all your assets minus your total liabilities. For example, if you own a home worth $400,000 and have $150,000 saved in retirement accounts you have $550,000 in assets. If you have a mortgage balance of $300,000 and $50,000 in student debt, you have $350,000 in total liabilities, so your net worth is $200,000. Net worth is more useful for measuring wealth than earnings, since earnings do not account for debts or assets you already have.
Growing Net Worth
It is possible to have high earnings and a low net worth or to have low earnings and a high net worth. For instance, a recent business school graduate with a high salary and a large load of student debt might have high earnings but little net worth. On the other hand, an unemployed person who inherits a large estate might have a high net worth but low earnings. Earnings can help you build net worth over time if you use earnings to pay off debt, increase savings or to make investments. Someone with high net worth and no earned income can potentially grow net worth by saving or investing assets he already has to gain passive income.
The federal government imposes income tax, Social Security tax and Medicare tax on earned income. Unearned income is not subject to Social Security tax or Medicare tax and certain types of unearned income, like capital gains and dividends, are subject to special tax rates that are lower than normal income tax rates. This means individuals with high net worth who invest money to make unearned income can face lower tax rates than people with lower net worth who have high earned income.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.