People can pick up and move homes for many good reasons. Sometimes it’s a job, sometimes to be closer to loved ones, and occasionally it’s to retire to cheaper location.
This process of moving to ensure a wonderful retirement is commonly known as geo-arbitrage. It’s very common for retirees to move, and something the Tako family has been considering for quite awhile now.
Along with a cheaper cost of living, we’ve been looking for a nice, safe, quiet place to finish raising our kids.
It’s been a slow process, and we’ve been in no rush to move — Washington has been a pretty great state to live, and it’s fairly affordable when compared to places like California, Hawaii, or New York.
However, one of the greatest financial advantages of living in Washington State could soon be disappearing…
A Tax On Washington
Until recently, Washington State enjoyed the status of being a “no income tax” state. To pay for all the necessary services we’ve come to depend on as part of modern society, the state of Washington has had high sales-taxes (around 10%) and higher than average property taxes (around 1% of assessed property value).
This is very similar to other “no income tax” states like Alaska, Texas, Wyoming, Nevada, Florida, Tennessee, New Hampshire, and South Dakota.
It’s a taxation method that’s worked fine for decades in Washington, and all those other income tax free states. Washington has been a great state to live, work, save, and invest in. There’s plenty of jobs, and we have one of the highest minimum wages in the country at $13.50/hr!
Unfortunately, due to a upcoming change in state law, this income-tax free status may be ending very soon.
Our state legislature has decided (in all their great wisdom) to enact a 7% capital gains tax on capital assets — like stocks, and bonds. This tax would only apply to individuals with capital gains over a value of $250k in a given year. Real estate would be exempt, as would the sale of sole proprietorships.
You can read the current version of the bill here, as well as track the bill on the Washington State Legislature website. The bill hasn’t completely passed yet, but it’s predicted to in the next few weeks.
The idea behind the bill is that “wealthy” people should to be taxed more to deal with growing wealth inequality. In other words, to help fix the wealth gap between the “haves” and the “have-nots”.
In theory this is a fine idea — Wealthy individuals earning many many times their level of spending should be able to help out the society that made them ultra wealthy in the first place.
That’s a great theory… but what if this capital gains tax actually impacted middle-class retired people? Or those soon to be retired?
Is It Really A Tax On The “Wealthy”?
After reading the bill, it didn’t take me long to realize that my own family would fall subject to this capital gains tax very soon. If the S&P 500 earns an “average” long-term return of 7%, it would take a mere $3.5 million dollars before a family became subject to an annual capital gains tax.
That’s right where the Tako family is today! In a good stock market year, we can easily see gains that exceed $250k. (Not every year mind you, but we’re close). Normally we don’t harvest our capital gains every year. Instead, we try to live-off our dividends (if possible) and let most of our assets keep growing. Thankfully, dividends are not subject to this capital gains tax.
Last year we spent a $41,891 of our dividend income of $60,737. It was a COVID-19 year, so our spending was a bit lower than normal. We typically spend around $55,000 dollars a year.
This is hardly “wealthy family” territory! We spend less than the median American family ($63,000 annually according to the Census Bureau).
We’re NOT fancy billionaires driving luxury European sports-cars, and flying around the world on private jets. We’re a simple family who lives in a 2,500 square foot home with two used cars (worth less than $10,000 each). In a non-COVD year, we feel privileged if we can take one decent-sized family vacation per year.
So are we the definition of the ultra-wealthy? A middle-class family just trying to reach financial independence?
Hardly! 2019 and 2020 were definitely good years for the stock market. We saw unrealized capital gains that we would be subject to this capital gains tax if we ever decided to harvested those gains.
Once this new law passes, we could even accidentally become subject to 7% capital gains just by shuffling our assets around (a process sometimes called portfolio balancing).
A Tale Of Three Earners
Imagine for a moment, you have 3 individuals who live in Washington State — A tech executive, a real estate mogul, and a hard-working saver.
Each of these individuals exists at a different level of the wealth spectrum. One is extremely wealthy. Another is what I would term “upper-middle-class”, and one is merely middle class.
All three individuals derive their income through different methods.
(Yes, I know this sounds like a bad joke, but bear with me — It’s no joke!)
Our tech executive earns an annual salary of $400,000/year from his job at the tech firm where he works. In addition, he earns an annual bonus of $200,000 and annual stock awards of $300,000 from this tech company. Over the years he’s made millions from the tech firm where he works, and he has many millions in unrealized capital gains from those stock awards. His net worth is over $10 million dollars. By most measures, he’s a member of the 1% and extremely wealthy.
Since Mr. Tech Executive earns most of his income as a salary he won’t be subject to taxation in Washington State. And, since he intends to retire out of state, he can simply defer selling stock awards until he’s established out-of-state residence.
Now, we move on to the real estate mogul. Mr. Real Estate Mogul may have started out earning a good salary from a law firm, but he saved his pennies and invested them into real estate. He doesn’t work at the law firm anymore. Instead, he now manages his real estate portfolio, deriving his income from real estate assets.
Over the years he’s built up quite the portfolio of rental properties and office buildings. He now collects an annual income of $250,000 after expenses and mortgages are paid. Some years he sells property and realizes a large capital gain that exceeds $250,000. Since this capital gain is derived from real estate, it’s exempt from the new capital gains tax. The real estate mogul can happily spend (or reinvest) those gains without taxation in Washington.
And finally, we consider Mr. Saver. Over the years Mr. Saver worked numerous middle-income jobs — nearly all of them earning less than $100,000 a year. He (and his family) lived frugally, only spending what they needed. After a couple of decades they managed to save and invest a couple million dollars, intending to reach financial independence (and eventually “retire”).
Since the stock market has been having some great years, Mr. Saver saw his invested savings grow to roughly $3.5 million dollars. That’s roughly $1.5 million in capital gains, and he now considers himself financially independent (aka “ready for retirement” in traditional parlance).
There’s a problem however — Unlike those other Washington State earners mentioned earlier, Mr. Saver would be subject to the new capital gains tax in Washington state. This could endanger his retirement because that $1.5 million is subject to the 7% capital gains tax as soon as he sells!
Would The Real Mr. Saver Please Stand Up?
If you haven’t guessed by now, I’m actually “Mr. Saver” in the story above, and this new state law brings on a whole new dimension to living, earning, and retiring in Washington state.
Honestly, I’m outraged that a simple middle-class person like myself would be subject to this new taxation. Meanwhile, extremely wealthy business executives and real estate moguls can easily avoid taxation just by virtue of how they earn an income.
I seriously doubt most retirees with a decent retirement savings will want to remain in Washington State after this new law gets enacted. To make matters worse, the new capital gains law has no provision for inflation. Meaning, more and more middle-class savers like myself will eventually be subject to this capital gains taxation as inflation works its magic.
(Update: It seems like the bill *does* have a provision to adjust for inflation. I just missed it.)
Hell, even Jeff Bezos recently stepped down as CEO of Amazon. As you probably know, Amazon is headquartered in Seattle Washington. As CEO, he was a resident of Washington. That’s all done now. Stepping down means Bezos is probably changing his residence to another state. As chairman of Amazon, he’ll only need to come back for board meetings.
(Let’s be honest — If you were the richest man on the planet, you would probably try to avoid taxation too.)
Say goodbye to Jeff Bezo’s billions Washington State! And the hundreds of thousands of dollars they might have realized from my own (relatively) pathetic retirement portfolio.
That’s right, we’re moving! In the past it seemed like geo-arbitrage was probably a good idea to maximize our retirement dollars, but now it seems like a necessity.
Why? We’re not actually that wealthy, but Washington State seems to think we are. In order to maximize our retirement years we have to be careful. We have a mere $3.5 million in capital assets, and a few hundred thousand in home equity, along with some emergency cash. All that hard-earned money can disappear very quickly if we’re not careful about where it goes, how it’s taxed, and how much we spend.
During all of our years saving and investing, we never planned to pay an extra 7% of our wealth in taxes.
We still like Washington state, (and even have family here) but our retirement now seems at risk if this new law passes. If it does, we’ll move to a no-tax state like Texas, Florida, or Nevada.
While I don’t disagree with the concept of having ultra wealthy people pay-up, it’s the fact that it doesn’t actually tax them that bothers me. Instead, it’s middle class savers like myself that get caught with the bill just because of how we derive our income. This seems wrong to me.
It’s the final straw that broke this camel’s back. Unfortunately, I have no political power and there’s nothing I can do to change this. We can simply put-up with it, or leave. Leaving seems like the better option to me.
My only question now is, “Where shall we move?”
Do you agree or disagree with this new tax on capital gains? Is it fair? I’d love to hear your thoughts in the comments!
[Image Credit: Flickr]