Could Capital Gains Lose Some Preferential Tax Treatment?

by: Larry MacDonald

You would think poor stock market returns and/or job losses would be perceived as the No. 1 threat to retirement security these days. Not so: that spot is claimed by high taxes, according to a recent survey. Inflation was not far behind.

One might initially be puzzled by taxes and inflation being the greatest worry for those contemplating their golden years. But then, recent coverage of government budgets reminds us of a possible explanation. When governments run gargantuan deficits to finance massive stimulus and spending packages, citizens begin to fear it means higher taxes down the road.

The wisdom of the crowd may prove prophetic. As government deficits get bigger and bigger, so does “regulatory risk,” i.e. the pressure to change the rules and regulations in the middle of the game.

Take the decision to contribute to a tax-deferral plan, like registered retirement savings plans. High income persons may see them as worthwhile because their tax rate in retirement is expected to be lower. But that assumes marginal tax rates stay where they are. What if they ratchet upward so by the time one gets to retirement, tax rates are higher than the rates at time of contribution? The deferral is not so great.

Don’t forget the other government tax called inflation. Governments confronted with massive debt problems have been known to inflate their way out of those burdens. So even if statutory tax rates and laws remain unchanged, saving for retirement could be tripped up by real returns coming in below required levels, or even negative.

Funny, it seems, the greatest fears about the future originate with government yet people continue to expect it to solve all their problems. Maybe if they stopped expecting so much from their politicians it would be a little easier to enjoy the fruits of one’s labour.

Appendix: Other considerations: as funding pressures mount on government, could withdrawals from tax-free savings accounts become taxable? Could capital gains and dividend income lose some of their preferential tax treatment?