The "fiscal cliff" is on the horizon. The term is shorthand for a series of federal spending cuts and tax hikes that will automatically go into effect in January 2013, if Congress doesn't act to override them. These automatic measures originated in Congress last year as part of a compromise to pass the Budget Control Act of 2011.
The tax hikes include ending the temporary reduction in the payroll tax (which funds Social Security), ending some tax breaks for businesses, changing the alternative minimum tax, and inaugurating some taxes to start paying for the Affordable Care Act. They will also affect certain tax credits for college tuition and low-income families.
At the same time, the White House has detailed a whole list of budget cuts that will affect over 1,000 government programs, including $55 billion in defense cuts and $11 billion in lower Medicare payments.
The fiscal cliff presents a giant air pocket for the entire economy. But here are six ways these tax hikes and budget cuts could affect the nation's seniors in particular:
1. Increase taxes on your dividends. Income that retired people receive from their stock and mutual fund investments is currently taxed at a maximum rate of 15 percent. If we go over the fiscal cliff, dividends will be taxed at ordinary income rates, up to 40 percent. According to investment firm Goldman Sachs, companies in the S&P 500 index on average pay a dividend yield of 2.1 percent before tax. With the current tax rate of 15 percent, the yield declines to about 1.8 percent. After the fiscal cliff the average dividend yield would fall to an almost-insignificant 1.2 percent.
2. Increase taxes on capital gains. The maximum tax rate on long-term capital gains (investments held longer than a year) will increase from 15 percent to 20 percent. So, for example, if you bought AT&T ten years ago, you likely paid about $27 a share. Today, those shares are priced at about $33, for a little over a 20 percent gain. Sounds good, doesn't it? But in fact, that 20 percent gain just barely makes up for inflation. After you pay 20 percent of your gain in taxes, you've actually lost purchasing power.
3. Social Security. Arguably, the fiscal cliff brings good news for Social Security. No, your benefit will not get any higher. But the fiscal cliff ends the 2 percent payroll tax "holiday" put in place by President Obama in 2010. Since the payroll tax funds Social Security, the higher tax will repair some of the damage done to the funding of the program.
4. Cutbacks to Medicare. The fiscal cliff aims to cut some $11 billion out of Medicare, in part by lowering payments to doctors. This could mean that individual patients will have to pay the difference. Alternatively, it could put cost pressures on medical facilities, forcing them to reduce staff. Lower payments could also lead doctors to limit the number of Medicare patients they will see. The fiscal cliff could make it harder for some people to find a doctor, and could mean longer wait times and a lower quality of service for those who do.
5. The value of your home. No one knows how the fiscal cliff will influence mortgage rates. But with less government spending, less employment, less after-tax income, and a less robust economy in general, it's hard to see home prices rebounding in any meaningful way. In fact, the fiscal cliff could rachet down the value of your house yet again, as funds are squeezed out of the housing market to shore up the rest of the economy.
6. The value of your investments. In theory, the value of an investment consists of the after-tax sum of all future returns. If, as many experts predict, the economy suffers after going over the fiscal cliff, then those returns will be lower. To add insult to injury, the lower returns will be taxed at a higher rate. It only makes sense that the stock market, as well as private business investments, would settle to a lower level. High-dividend stocks, defense stocks, and banking stocks might be the biggest losers. But even more stable investments in health care, oil, and agriculture would probably be a bad bet, since going over the fiscal cliff will certainly leave everyone black and blue.
Tom Sightings is a former publishing executive who was eased into early retirement in his mid-50s. He lives in the New York area and blogs at Sightings at 60, where he covers health, finance, retirement, and other concerns of baby boomers who realize that somehow they have grown up.