How Dare You Save For Retirement!

The U.S. government is planning to punish consumers who plan for their own retirement.  Whether you have a taxable brokerage account, or a tax-deferred retirement account (401(k), Keogh, Roth or traditional IRA) there’s a political bull’s eye painted on your back.

Dividend and capital gains taxes are set to increase as the Bush tax cuts expire at year’s end.  First, dividends will increase from the current 15% rate to the top ordinary income rates with a top rate of 39.4% plus an Obamacare surtax of 3.8% — for a total of 43.4% in 2013.  Second, capital gains will go from the current 15% and to 20% plus the Obamacare surtax of 3.8% in 2013.  The planned dividend and capital gains increases will be 28.4 and 8.4 points, respectively.  Shares typically get 20% of their returns from dividends and 80% from capital gains, so the effective, blended new tax rate will be 27.4%, almost double today’s 15%.    

At $34,500 taxable income today, your marginal tax rate is 25% and will rise to 28% in 2013.  For a $100,000 taxable income today, it’s 28% and 31%, respectively.  For consumers with incomes above $34,500, the tax rate on dividends will rise between 86% to triple the current rate.  This is not class warfare against the rich – it’s an attack on ordinary consumers who save for their own retirement.

The higher tax will make stocks worth less to investors and stock prices will drop accordingly.  In effect, pre-tax yields on investments will have to increase.  The higher yield means that some future investment projects under consideration will no longer meet the higher yield threshold and starting them would no longer be justified.  That will reduce new employment opportunities.  Is this the jobs program we were promised?

When the taxes increase, the stock price drop will cut the value of an investor’s portfolio.  For retirees who skewed their portfolio to favor dividend-paying stocks, the drop will be most pronounced because dividend taxes will have increased proportionately more than capital gains taxes. 

When these taxes are increased, dividend-paying companies are likely to shift earnings payout away from dividends and into buy-backs of stock, since that puts more value into the shareowner’s after-tax pocket.  Under new tax rates, payout in the form of share buy-back creates a capital gain which will be worth $0.762 after tax for the shareowner.  In contrast, a $1 dividend will be worth just $0.566 after tax.  But there’s a catch – for the shareowner to benefit from the share buy-back, the shareowner must sell the stock at a price lower than before taxes were increased.  This will hit retirees harder because they generally cannot do without income until tax policy changes and prices recover.

Investors put substantial effort and research into their investment selections.  We should have put the same analytical effort into selecting politicians.  None of us can afford this destructive tax policy from our intransigent elected officials.

Alan Daley is a retired businessman who lives in Colorado and follows public policy from a consumer’s perspective

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