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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MrFireStation 
Don’t forget the State Capital Gains Tax which puts Minnesota at 53.3% under the Biden Proposal.
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Ouch. Hello Florida!!
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Canadian here and taxes are much higher than what Biden is proposing. The devil is in the details with tax changes and it requires some time to review before really knowing the true impacts. I will always keep an eye on any tax changes and review my FIRE plans to and make some changes if required.
When talking about taxes there seems to be a lot of pollical spin in the media. The term “FUD” (fear, uncertainty and doubt) comes to mind. No one can tell the future and depending on if you have an optimistic or pessimistic view point it can be something to worry about or not.
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Unknowable. As currently pitched, it doesn’t affect me. But if capital gains taxes increase for the mega-wealthy, who have legions of lawyers and accountants to protect their assets, the feds will slide down into my pockets just as sure as any snake slides down to its den.
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Here is a scenario where the $1 Million cap on Capital Gains could really hit someone who is not a wealthy hedge fund manager. Imagine a small business person who wants to retire and they sell their business for two million. This is a one time event that will push the person into highest tax bracket and fail to consider the impact of inflation.
I would argue that this person isn’t super wealthy. Probably the guy next door who work his butt off .
The tax code back in the good old days that the politicians use as their reference point for higher taxes used to have ten year income averaging to not take away half of a once per life liquidity event. As a parting comment, the root cause of this problem is that politicians seem to be really bad at Math.
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Yes – that would be true for farmers too, as those are just small businesses. I’m guessing that faced with that, people will structure the sale of a business so that they will receive $999,999 a year for a number of years. That will cause the government to start pushing down the threshold to eliminate what they will brand as an “unfair loophole”. 😦
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“Sure as any snake slides down into it’s den” LOL – great analogy!
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I’m curious what kind of split you have between taxable and tax-deferred (or even tax-free) investments? For money coming from a 401k, IRA or Roth, the capital gains rate is mostly inconsequential, so this change would be most impactful if a large % of your money is in taxable accounts (perhaps not uncommon for many early retirees, but less so for most traditional retirees).
As to the tax rate itself, I wouldn’t be surprised to eventually see capital gains taxed as ordinary income — it feels we’re headed in that direction. But, I’d expect this would still be subject to marginal/progressive tax rates, so doubt anyone but the wealthiest would pay the top rate.
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Probably 2/3rds of our portfolio is taxable. The rest is in 401Ks/IRAs, which are taxed as ordinary income. In the example, I applied the higher tax rate only to our regular brokerage accounts.
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