When the Bush tax cuts — formally known as the Economic Growth and Tax Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 — were implemented, Americans faced lower tax rates than any time since the 1970s. Now, they are set to expire at the end of 2012 — and it has everyone wondering what it will all mean for their finances. Unfortunately, with the all the political debate (Did the cuts help the economy or hurt it? Will President Obama extend parts of them for another year? Who will be affected?) it’s hard to tell what the tax landscape will really look like in 2013. The possibility of change has one group especially worried: Retirees and those approaching retirement.
After the stock market crash and ongoing recession, this group has taken a major blow, and many of them can’t afford anything else that might put a drain on their savings. Here we’ll take a look at some of the potential consequences for this group if the Bush tax cuts are repealed.
Higher Income Tax Rates Without Bush Tax Cuts
The Bush tax cuts include provisions that reduce income taxes across all brackets, and create a 10 per cent bracket for the lowest income earners. If the cuts expire, the lowest tax bracket will rise to 15 per cent, the existing 25 per cent bracket will be replaced by 28 per cent and the existing 28 per cent bracket will be bumped to 31 per cent. The existing 33 per cent bracket will be replaced by a 36 per cent bracket, and the existing 35 per cent bracket will be replaced by a 39.6 per cent bracket.
Obviously, higher tax rates could have an effect on those approaching retirement simply by cutting into their take-home pay. For those who struggle to contribute to retirement savings, pay down their mortgages and make other smart pre-retirement moves, more taxes could make meeting their retirement saving goals a little bit harder. It would also affect the tax rate of retirement income withdrawals from retirement plans such as IRAs and 401(k)s, which taxed at income upon withdrawal.
However, the Obama administration has repeatedly voiced its desire to preserve the tax cuts for singles making less than $200,000 and couples making less than $250,000 per year. Under this plan, the Bush-era tax cuts would be extended for everyone else. According to the Brookings Institute and Urban institute, this means about 4 per cent of tax payers would be faced with higher taxes, while tax rates for the rest of Americans would remain the same.
Higher Capital Gains Taxes
Right now, the maximum federal tax on long-term capital gains and dividends is 15 per cent. In 2013, they are set to increase to 20 per cent; dividend taxes will also go up across the board, up to a maximum of 39.6 per cent compared to the current 35 per cent maximum rate. The 0 per cent rate that currently applies to those in the lowest two rate brackets will also be boosted to 10 and 15 per cent.
Higher rates on capital gains and dividends is something that could affect a number of investors. And, because a lot of the wealth in the U.S. is locked in retirement accounts, this could mean interest income, dividend income and capital gains inside retirement plans could face higher taxes, whether in the year they occur, or when they are withdrawn (depending on the type of account). That means that retirees may have to stretch their incomes a little further.
In the past, Obama has said that the increased rates would only be applied to higher tax brackets, much like those for income tax. Whether this portion of the Bush tax cuts will be allowed to expire, or whether some portion of will be extended, is not clear at this time. Critics of the tax cuts argue that the rate on long-term capital gains accrue mostly to taxpayers at the top of income scale. According to the Tax Policy centre, a nonpartisan research group, eliminating the Bush tax cuts to capital gains and dividends would reduce the after-tax income of households making more than $1 million per year by about 5.8 per cent, and would decrease the after-tax income of all American households by about 0.9 per cent.
A More Expensive Marriage Penalty
The Bush tax cuts amended the so-called marriage penalty, which can cause a married couple to pay more taxes than when they were single. Currently, the standard deduction for married filing jointly taxpayers is double the amount for singles. In 2013, joint filers in the bottom two brackets could go back to getting only about 160 per cent of the standard deduction allowed for singles.
Clearly, this is another instance where higher tax rates could cut into retirees’ bottom lines, depending on their tax bracket and how they file. However, this one Bush tax cut that is pretty popular across the board, and it appears likely that it will stay in place.
What To Do
So how will the expiration of the Bush tax cuts affect retirees? It’s hard to say, because so much of how the current tax structure will actually be changed remains up in the air. If you’re concerned about the effect your tax liability may have on your portfolio, visit a qualified tax professional. He or she will be fully versed on the latest tax rules and how to mitigate their impact. Based on the political arguing that’s happening around these tax cuts – and what portions of them will be preserved – the effects could be quite personal, so it’s important that people address them individually.
The other thing to keep in mind, though, is that taxes are something outside of your control. What really keeps most people from retiring comfortably is too much debt, limited efforts at saving and a lifetime of living beyond their means. No matter what happens in government, your spending and saving patters are things you can control. And despite all the arguing that goes on in Washington, they’re also the factors that will have the greatest impact on whether you can retire comfortably.
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