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Capital Gains and Retirement Income

Mike has a nice WaPo excerpt on the impact of the McCain and Obama tax plans. It has a beautiful graphic that tells the story very eloquently. However, a question came up in the comments:

This may be a strange place to ask for financial information, but I just had a conversation about Obama’s tax plan with my USAmerican mother. Though she is no fan of McCain, she told me that Obama’s plan significantly increases the capital gains tax, regardless of total income, so even for someone whose income might be around $50K, if the income is mainly from investments (ie for a retired person) they would pay more taxes. Does anyone know if this is true, or is it a McCain scare tactic implying that Obama wants to stick it to seniors with a fixed income? (As a Canadian, I plead justifiable ignorance of the US tax system.)

Mike just changed his layout, and every time he does, I get locked out of commenting for a while, so I can’t respond there. But this is worth its own post anyway.

Most Americans with retirement savings have them in a 401(k) or 403(b) plan. These numbers refer to the sections of the tax code in which money going into and coming out of these plans is given special tax treatment. The biggest difference between them is that 401(k) plans also provide tax benefits to the sponsoring employer. 403(b) plans are sponsored by nonprofits and government agencies that don’t need the tax breaks.

Now, I’m no expert on Section 401(k) or 403(b), but Wikipedia confirms my lay understanding that “[t]he character of any gains (including tax favored capital gains) are transformed into ‘ordinary income’ at the time the money is withdrawn.” In other words, no capital gains taxes. Just income taxes.

This makes sense, considering that the purpose of these plans is to encourage citizens to prefund their own retirement rather than relying on the government. There is no incentive for the government to take anything more than they would have taken if the money were taxed as the employee earned it instead of it going into the plan.

To make a long story short, Theo’s mama has nothing to worry about from a capital gains tax increase. In fact, she’s a whole lot better off under Obama’s plan.

Whether it’s McCain’s camp doing the scaremongering? That one I can’t answer.

Update: Here is some more information from Snopes on additional lies being spread about Obama’s tax plan.

Comments

  1. says

    Thanks for the Snopes link. I will pass it on to my mum (who is a very internet savvy 72-year-old :) ). For reasons I won’t go into here, much of her investments are not in a 401k, but it looks like, based on her income level, she has no reason to fear Obama’s tax regime.