What is the Capital Gains Tax?

You probably already know about income taxes and payroll taxes because you see them in every paycheck.

But there’s another big tax on any money you save and invest. It’s called the capital gains tax.

When you save for retirement or save money for college, you usually invest that savings in things like stocks or bonds because you hope they will go up in value. When you sell those stocks and bonds, the difference between what you paid and what you sold them for is called “capital gains.” Unfortunately the government taxes that money with something called the “capital gains tax.”

Let’s say you invest $1,000 in a mutual fund to save for retirement. This is money was already taxed when you earned it. But when you retire 20 years later and sell that stock for $10,000 you will have to pay capital gains tax on the $9,000 in growth. The top tax rate is almost 24 percent, meaning you would be forced to hand over $2,000 back to Uncle Sam.

Along with being a “double tax” on your money, the capital gains tax does not adjust for inflation. So when you sell your stocks and bonds decades after you bought them, the money you collect isn’t worth as much as the money you bought them for. But when the government takes capital gains it pretends that money is worth the same amount. Costing you more money in tax!

The government should be encouraging people to save and invest for the future, but the capital gains tax discourages people from doing that. So the next time you hear someone complaining about the income and payroll taxes taken out of their paychecks, remember there is also a savings tax that can hit you when you least expect it.