After President Biden was elected, I went through his proposals and could not find any that really would affect me directly in a negative way. The one concern I noted – before the Republicans lost power in the Senate – was a change in the capital gains tax.
Now that we have one-party control in Washington DC – which is always scary – talk of a change in the long-term capital gains tax from 15-20% to being taxed as ordinary income has my attention. Long-term capital gains have always had a lower rate of taxation as they are considered a form of double-taxation, they are not indexed to inflation, and they fuel investment (a positive) versus corporate borrowing (a negative).
What Biden has proposed seems limited: a change in long-term capital gains only for households making over $1 million dollars a year. That’s definitely not me. That said, those thresholds have a way of moving down pretty quickly. The income tax was also started as a “soak the rich” scheme for a small % of taxpayers, but quickly came to include everyone.
Since I have a retirement spreadsheet that includes the long-term capital gains rate, I decided I would do a little fun with numbers to see what the difference is between 20% and 39% (the ordinary income tax rate Biden has proposed). The chart shows our nest egg today and what it is forecast to do over the next 38 years …
You can see in the first scenario (20% taxation), our nest egg stays pretty steady throughout our entire lifetime. This is how we planned our future. There is a lot of uncertainty in life and it is based on average rates of investment growth. It might come in better or worse depending on how our investments do over the years, but we have some cushion.
Scenario two (39% taxation) leaves us no margin for error. About 95% of our investments would be taken through the higher rate of taxation. If the markets do well, we’ll still be fine, but if economic growth is slower than in the past, we’ll be broke in our 90s. Not a scenario I would relish.
Of course, scenario two assumes we would fall victim to the higher tax rate immediately – I don’t see anyone proposing that. It would probably take a few Democrat-run administrations for that to happen. And, it assumes we wouldn’t do anything to blunt the impact of the change.
Still, it is instructional in terms of how incredibly sensitive our retirement plan is to the long-term capital gains tax alone. Combined with a little increase in inflation and the whole plan collapses.
While I fear for the economic future of the country given all of the debt we have run up with unrestrained spending, this proposal is one that I honestly hope will fail. As Jefferson said, “a government big enough to give you everything you want is strong enough to take everything you have.”
How big an impact would a long-term capital gains tax change have on your plans?
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