Markets took a beating last Thursday as President Biden announced a bombshell new tax plan. The details are still being worked out, but the biggest news is that investors could pay a tax rate of up to 43.4% on long-term capital gains, higher even than their highest personal income tax rate. That could have a severe impact on stock markets, reverberating throughout the economy and negatively impacting the value of your retirement savings.
There are four potential impacts from this tax proposal:
- Shift from long-term to short-term investments
- Shift to alternative assets
- Increased popularity of tax-advantaged retirement accounts
- Lower stock prices
The devil will be in the details, of course, and the severity of any impact to markets could be dependent on those details. But with left-leaning economists such as Paul Krugman already providing intellectual cover for Biden’s tax plan, don’t be surprised if Biden and his advisors fail to anticipate the negative effects of his plan and fail to make changes to mitigate those effects.
1. Shift From Long-Term to Short-Term Investments
The first and most obvious effect of Biden’s tax proposal is that it could result in a shift from long-term to short-term investments. Currently capital gains taxes top out at 23.8% for the top earners, whereas short-term capital gains are taxed at income tax rates, which top out at 37%. That incentivizes long-term investment, which results in market stability and more secure funding for companies issuing stock.
Biden’s tax plan would boost the top income tax rate to 39.6%, and the top capital gains tax rate to 43.4%. The incentive then might be to hold investments for less than a year. That could result in a even more casino-like atmosphere in stock markets than exists today.
It could also result in the development of special investment vehicles that launder investments so that top earners could engage in repurchase agreements, selling their assets at 364 days and buying them back the next day at the same price plus some nominal sum. Of course, that would mean tax consequences each and every year, something which investors don’t have to face today. Overall, the investment atmosphere when it comes to stocks is going to be very different under Biden’s plan.
2. Shift to Alternative Assets
There could also be a shift from stocks and bonds to alternative investments such as precious metals, real estate, or other tangible assets. Those are assets that are generally held for longer periods of time, aren’t always immediately liquidated by long-term investors when they need cash, and can be less sensitive to changes in taxation. Because precious metals are so often invested in through a gold IRA, which is already subject to income tax rates on distributions rather than capital gains, this levels the playing field to make an investment in gold more competitive with investments in stocks or bonds.
3. Increased Popularity of Tax-Advantaged Retirement Accounts
Tax-advantaged retirement accounts such as 401(k) and IRA accounts have strict limits on annual contributions, and some high-earning households aren’t eligible to contribute to them. But overall these tax-advantaged retirement accounts could become more popular as a result of Biden’s tax plan.
Currently income from tax-advantaged accounts is taxed at income tax rates. That could be up to 37%, and would rise to up to 39.6% under Biden’s plan. With long-term capital gains tax rates maxing out at 23.8%, it’s no surprise that many long-term and high-income investors choose to invest in non-tax-advantaged accounts. But with that 23.8% rate rising to 43.4%, and income tax rates rising to 39.6%, investing in tax-advantaged accounts suddenly makes more sense.
Those high earners who are affected by the tax increase and who aren’t already investing in tax-advantaged retirement accounts can be expected to max out their contributions. And don’t be surprised if these high earners find unique ways to shelter even more investment income from taxation, such as by becoming self-employed to start a SEP IRA for its $58,000 maximum annual contribution.
4. Lower Stock Prices
The combined effect of these tax changes could result in lower stock prices, both on the broader market and for individual stocks that right now may be high fliers. Some stocks will be sold in anticipation of higher taxes, while others will be sold only after any new tax rules are made final.
While the devil is always in the details, the effect of higher taxes on anything means that there will be less of that thing produced. Raising taxes on capital gains means that investment will be curtailed, there’s no doubt about that. That will likely trickle down to the average investor, who may see lower stock prices as a result of a drop in demand from high-income investors subject to higher taxes. And that in turn could result in a fall in the value of your retirement savings.
What Can You Do?
If you’re one of the investors who will likely feel a direct impact on your investments, you’ll obviously want to consult with a tax advisor. But even if you’re not in the highest income bracket, you’ll probably want to take a close look at Biden’s tax proposal to see how it might affect you.
You’ll also want to do your research to see which stocks might be most impacted by Biden’s new tax rules, and there’s plenty of material out there to pore through. Markets are still trying to understand Biden’s new tax plan and digest how it will affect them. But again, more taxes on capital gains means fewer capital gains; fewer capital gains means fewer gains for investors, you included.
With the playing field between IRAs and brokerage accounts becoming more level, and with gold and stocks now on a more even footing, now might be the time to start reconsidering the makeup of your investment portfolio. If you’ve been thinking about investing in gold but have hesitated, maybe it’s worth taking a look at gold again.
Gold has protected thousands of investors over the years against inflation, turmoil, and crisis. And in the coming years it could protect you too. Talk to the experts at Goldco to learn more about how to protect your retirement savings with gold.