The Blatt Watch by Peter Blatt: The Fallout of the Fiscal Cliff: A Brief Guide for Retirees

From the desk of Peter Blatt

January 17, 2013

While the financial news and media outlets may have temporarily retreated from the fiscal cliff deal (or at least their nauseating round-the-clock coverage of it), I’m not ready to yet. That’s because this legislation is so all-encompassing that it literally affects nearly every American. It certainly affects every business owner, every waged or salaried employee, and yes, it even reaches every NASCAR team owner, too.

But perhaps the bill affects no one else quite like it does for seniors and newly minted retirees. And it’s not so much what’s in the bill as what this bill represents as a prequel to what we have in store just around the corner: the February debt-ceiling showdown.

Before we go there, let’s a take a step back and finish what we started. How does this bill affect seniors?

Income tax rates rise for the highest earners

This is the most obvious provision that affects retirees who are high earners. As I described in last week’s Blatt Watch, this deal ensures that ordinary income above $400,000 a year ($450,000 for married joint filers) will be subject to a tax increase of about 4.6% to a maximum top rate of 39.6%. A majority of America’s highest earners that fall into this tax bracket derive their income from investments like business equity interests, dividends, and other sources of income produced by a variety of assets, of which earnings are taxed at the capital gains rate.

But not all income produced by vested assets qualify to be taxed at the capital gains rate. Some income, like that which is derived from money market mutual funds or as a loan against a life insurance policy, for example, can be taxed as ordinary income and therefore subject to the higher tax rates. The qualifications and differentiation for what’s prescribed as ordinary income versus capital gains income is governed by the IRS, and the laws which dictates this criteria always in flux.

It’s a good idea to take time to catch up and find out if any assets your holding could potentially be taxed at the ordinary income rate, because if so, the rate at which you pay has essentially just jumped more than 250% from 15% (capital gains rate) to 39.6% (new top tax bracket for ordinary income).

Capital gains rate rises to 20%

Many of our retiring or retired clients depend on investment income and dividends to carry them through many, many happy years to come, and that’s true for those at the highest end of the earning spectrum on down to the most modest of earners. For those of us who have enjoyed a meager 15% tax rate on our income derived as capital gains for the better part of the last decade, we’ll see a 5% increase in that rate to 20% (but only for those high earners that meet the income thresholds stated above – $400,000 for a single filer or $450,000 for married joint filers).

Sequester cuts delayed

Finally, the bill has delayed automatic across-the-board sequester cuts that were set to kick on January 1st, 2013 as part of the deal reached summer 2010 to extend the debt ceiling. Much of the $1 trillion plus cuts that were scheduled to take place were designed to impact federal social services like Medicare, Medicaid, Social Security and defense spending, along with a myriad of other departments and services. Negotiations regarding the extension of the debt-ceiling limit will start up again in February, which is when the sequester delay is set to expire.

That brings me to my final point: what this bill does is great for a lot of retirees in many ways, including preservation of the Bush era tax cuts for middle and upper-middle class seniors, and perhaps not so much for those at the highest end of the earnings spectrum.

But I’m concerned that this bill foreshadows widespread impending and significant changes to federal entitlement spending, which may come as a result of partisan debt-ceiling negotiations which are all but inevitable in a matter of a few short weeks. I’ll expound more on this thought in the next edition.

Until next time,