How the Capital Gains Tax May Affect Retirees

How do you support yourself after retirement?
This is one of those questions that many young people have little interest in, choosing to cross that bridge when necessary. But if you are lucky and don’t keel over at your desk like Tim Russett, that bridge must be crossed.

So how does it work?

Yesterday, I had my first in-depth conversation with a financial planner and it was illuminating. Essentially, you live off of your pension (if you have one), your social security checks, gains from your investments, and the sale of your assets. In a best case scenario, if you can live off of pension, social security and investment gains, you can leave your assets intact. If you are forced to sell off assets, you will obviously have less to invest.

Of course taxes come into play and gains from your investments are subject to a capital gains tax.

So what is a capital gains tax?

The Internal Revenue Service explains: “Almost everything you own and use for personal purposes, pleasure or investment is a capital asset." When you sell an asset for a profit, that profit margin is your capital gain, and the IRS taxes you on it. Capital gains taxes vary depending on the income level of the tax filer and the length of the investment, with separate tax rates for short-term vs. long-term capital gains.

Presently, the long-term capital gains tax rate for most middle income people is 15%, having been reduced from 20% by President Bush in May of 2003. However, President Bush’s capital gains tax cut expires in 2010.

John McCain wants to make the Bush reduction to 15% permanent. Barrack Obama wants to increase the rate to at least 20% and possible as high as 28%.

So if you are a retiree and part of your income is from investments, instead of the Government taking 15% of each dollar of gain, in an Obama administration they will take 20% to 28% of each dollar of gain.

Let’s look at an example for a typical retiree:

Social Security = 12,540
Pension = 21,000
Investment Gains = 20,000 taxed at 15% = 17,000

Total Income: $50,540

If Obama is elected and he raises the capitals gains tax to 28%, total income for the retiree would drop: (20,000 taxed at 28% = 14,400).

Total Income: $47,940

Who can use that $2,600 more, the retiree or the federal government?