By Dr. Jim Dahle, WCI FounderI spend most of my time writing about the financial issues faced by high earners and the wealthy. Due to the severely progressive nature of our federal income tax system (where nearly half of “taxpayers” don't actually pay federal income tax at all), some of the “right answers” for high earners are not right for those in lower tax brackets. The 0% long term capital gains (LTCG) bracket provides numerous examples of this phenomenon.
The 0% Long Term Capital Gains Bracket
Let's say you have $10,000 in LTCGs. At what rate will it be taxed? That depends on how much other income you have. If you have no other income, those LTCGs are tax-free. You're in the 0% LTCG tax bracket. How large is this tax bracket? For single people in 2024, it ranges from $0-$47,026, and for those filing Married Filing Jointly (MFJ), it goes up to $94,051. It's actually bigger than that, though, because of the standard deduction of $14,600 ($29,200 MFJ). Thus, a married couple with no other income could earn $94,051 + $29,200 = $123,251 in LTCGs and pay $0 in federal income tax.
That's actually a whole lot of income considering that the average American household only earns a little more than half of that (about $75,000). Even if you have some other income, you can still have all of your LTCGs in the 0% bracket. Consider a married couple with $40,000 in Social Security income, a $20,000 pension, and $25,000 in Required Minimum Distributions (RMDs). They can still take up to $38,251 in LTCGs at 0%. The media often talks about how generous LTCG and qualified dividend tax brackets are for the uber-wealthy, but it's pretty clear to me that they're pretty generous for everybody and probably even more generous for low earners than high earners.
How does this affect financial planning?
Tax-Gain Harvesting
If you are only temporarily in the 0% LTCG bracket, you might want to take advantage of tax-gain harvesting. With tax-gain harvesting, you are actually realizing taxable gains (on which you don't owe tax) that you don't need to realize solely to raise your basis in the investment. Theoretically, this will lower future LTCG taxes when you are in a higher LTCG bracket later. That's very different from the usual advice we give to high earners to harvest their tax losses.
Retirement Asset Withdrawal Plans
The general rule of thumb in retirement for high earners is to first spend from your taxable account before getting into your retirement accounts—and then to blend your tax-deferred and tax-free account withdrawals as needed to control your tax rate. This approach minimizes taxes, boosts growth, and maximizes asset protection. However, for someone in the 0% LTCG and qualified dividend bracket, a taxable account acts almost exactly like a Roth IRA. It isn't taxed as it grows (as long as it only distributes qualified dividends), and there is no tax due when you “withdraw” from it. Rather than spending from taxable first, the proper approach is “blending” taxable and tax-deferred withdrawals to an acceptable overall tax rate.
More information here:
How to Achieve the Zero Tax Bracket in Retirement?
How to Use Tax Diversification to Reduce Taxes Now AND in Retirement
Roth Conversions
Roth conversions are generally a good move for early retirees. You are, in essence, moving taxable assets into tax-protected accounts. However, if you live in the 0% LTCG bracket (and expect to stay there), the only point of moving taxable assets into tax-protected accounts is to facilitate estate planning and asset protection. The taxable account is already acting like a Roth IRA, at least insofar as it is invested in tax-efficient, broadly diversified index funds. You'll probably do fewer Roth conversions—if you do any at all.
Deciding Whether to Use Retirement Accounts at All
If you are in the 0% LTCG bracket and expect to stay there, there isn't nearly as much benefit to contributing to retirement accounts at all. Yes, they allow you to invest more tax-efficiently in bonds, REITs, and other tax-inefficient assets and boost your asset protection, but they aren't going to do nearly as much for tax reduction. The dogma to “always max out your retirement accounts” and “don't miss out on that Roth IRA” and “invest in retirement accounts first” starts to break down.
More information here:
Comparing 14 Types of Retirement Accounts
Some High Earners End Up in the 0% LTCG Bracket
Don't scoff and assume this post does not and never will apply to you. There are plenty of situations where a very wealthy retiree spends time in the 0% LTCG bracket. Let's say you want to spend $200,000 a year in retirement. You can live a pretty nice life on $200,000 a year when none of it has to go to retirement savings, college savings, payroll taxes, disability/life insurance premiums, or commuting costs—and only a little of it has to go to income taxes. Spending $200,000 suggests a $4 millon-$5 million nest egg, depending on the value of any Social Security or pensions. But consider a married couple spending $200,000 when it comes from this breakdown:
- $40,000 Social Security
- $40,000 from traditional IRA
- $40,000 from Roth IRA
- $80,000 from a taxable account of which 75% is basis
Total: $200,000 in spendable “income,” and $100,000 in “taxable income.” The actual tax bill is $4,912.
In what LTCG tax bracket does this couple reside? That's right. It's 0%. In fact, they could spend a lot more from that taxable account before entering the 15% LTCG bracket.
It's important to know about the 0% LTCG bracket and to take advantage of it. It's really quite generous, and it applies to the majority of Americans and even many retired WCIers.
What do you think? When have you been or do you expect to be in the 0% LTCG bracket? How will you take advantage of that fact?
Thanks for pointing this out.
Getting taxable income down enough to take advantage of the 0% LTCG is a goal worth striving for.
Interesting tax tail angle. Personally, I hope I’ll never be in the 0% LTCG bracket again.
“Thus, a married couple with no other income could earn $94,051 + $29,200 = $123,251 in LTCGs and pay $0 in federal income tax.”
– Should this be stated in long term capital gains tax rather than federal income tax? You would still pay income tax on the 94,051 at federal income tax bracket levels which are different that the capital gains tax levels right?
No, the long term capital gains tax rate is instead of ordinary income tax rate, not in addition to it. Your federal tax bill for that year would be $0 owed. Though you may owe some to your state depending on their brackets and how they classify income.
No. Their only income is $123,251 in LTCGs. Thus they owe no income tax at all. The $94K and the $29K all refers to their LTCG income. That’s the only income they have. It was a contrived example to show a point.
As I entered semi-retirement a few years ago, it dawned on me how generous the 0% Div/CG bracket is and we have been easily “living the good life” within this bracket. However, it still seems to me that I should maximize Roth conversions within this bracket in preparation for the “widow(er) tax” when the brackets become much less generous. Any thoughts on this?
Separate issue but entirely possible Roth conversions are right for you. The first thing to decide when you’re thinking about a conversion is who is most likely to spend that money and what tax bracket will they be in when they do?
Some of the LTCG is growth from inflation. Your original basis is not adjusted for inflation. I’m glad some lawmakers have pointed this out and kept rates at a reasonable level. I think the discussion came up when there was a proposal to tax unrealized gains.
We are retired (not yet collecting Social Security) and Qualified Dividends from mutual funds and ETFs are the majority of our income, which are also taxed as capital gains. We’ve sold off mutual funds in taxable accounts that were making capital gains distributions to better manage our income, and annually have done a few Roth conversions, but overall our low-six figure income generates a mid-five figure tax bill (Married Filing Jointly) as Dr. Dahle indicates.
You mean mid four figure?
Oops – yes, mid four figure!
Thanks for this very interesting article. One possible caveat I need to understand though that will apply to my situation (and probably others) this year as we try to keep our income low for ACA health coverage is that if I take “free” capital gains for federal tax purposes those withdrawals would still count towards our income for ACA calculations and we’d be penalized (recalculating much higher medical premiums) for going over our $80,000 AGI income projection . Then next year we’ll only have one month of high medical premiums before we are both eligible for medicare and then our capital gains income can be much higher. Am I thinking this through correctly?
Yea, but as FinancialDave points out below, capital gains can increase the % of your SS that is taxed so if you’re not already paying taxes on 85% of your SS income keep that in mind.
Sorry I need a breakdown since I’m just learning how to think about what’s counted towards federal income tax vs LTCG tax…..
Could you explain how you get to this calculation?
“Total: $200,000 in spendable “income,” and $100,000 in “taxable income.” The actual tax bill is $4,912. “
So social security (40k) and tax deferred (40k) and your capital gains (20k) counts towards taxable income, correct? Do the capital gains just help determine tax bracket but are taxed at the LTCG rate? I’m getting myself confused. You can’t be double taxed…..
Thanks.
SN,
I can see how you could be confused, so let’s take it one step at a time for the 40k/40k/20k income as stated.
SS 40k + $40k ordinary income
49% of SS is taxed = 19,600 + 40,000 (RMD) = 59,600 AGI less 32,300 SD for couple both over 65
taxable income $27,300 = $2812 in tax.
Now let’s add the $20k LTCG
1. First thing that happens is this causes the rest of SS to be taxed up to 85% ($34k) so we have added 34-19.6 or 14,400 taxable income which is taxed in 12% bracket for $1728 addition tax caused by adding $20k LTCG. So final tax is 2812+1728 or $4540. Not the 4912 suggested by WCI.
2. In the end the marginal tax for adding $20k LTCG was 1728/20,000 or 8.6%.
FinancialDave,
Wow! Thanks for going into the weeds with me! Very clear. Do you have a finance blog?
SN,
Here is a recent article I wrote on the Social Security tax torpedo and how it affects those with higher SS benefits:
https://seekingalpha.com/article/4667028?gt=3f16a95cf65f3548
Fair point. Should have used software instead of just a quick calculation. But it’s <$400 off so I think the overall point remains. If you're having to optimize your finances for $400 you probably should have just worked a month longer before retiring.
This is what I don’t get about the “tax torpedo”. The rate is high, but some people in nominal terms won’t be affected much. Or do I have that wrong? I see all these warnings about the torpedo, but it seems hard for me to get too worked up about it. But maybe I’m missing something. Is it like people obsessing over IRMAA when it isn’t all that much money for them?
Yes, I think so. It’s a high rate but not a lot of money. It doesn’t last long. Hopefully most WCIers will have income so high they don’t have to worry about it.
Capital gains stack on top.
https://www.whitecoatinvestor.com/qualified-dividends-capital-gain-tax-worksheet/
WCI,
“Consider a married couple with $40,000 in Social Security income, a $20,000 pension, and $25,000 in Required Minimum Distributions (RMDs). They can still take up to $38,251 in LTCGs at 0%. ”
Absolutely not.
Let’s start with 40k, $20k, $25k – this tax is $3922.
Add $10k LTCG – this tax is now $4942,
Add the whole $38251 – this tax is $5140.
FinancialDave or WCI: would you have a sec to comment on this example?
Portfolio about $2.5M ($1M taxable), and plan to retire next year at age 50 on $84,000/year.
From age 50 to 60 I’ll withdraw:
$62,000 from taxable (about 50% basis)
$22,000 from 457 (required to start taking when I separate from employer)
MAGI (for ACA subsidy purposes) = $53,000.
AGI minus $14,500 standard deduction = $38,500
Taxable ordinary income = $22,000 – $14,500 (SD single) = $7,500
Federal tax on ordinary income = $750
Federal capital gains tax = $0
Oregon state tax (9%) of AGI = $3,465
Total tax = $4,215
Am I thinking correctly? Aside from moving up to Washington, is there a better way?
Brian,
I’m not sure I follow everything you are saying.
1. If you plan on needing $84k to live on, then you are going to need an extra $4k or so for taxes.
2. Why do you say you “must” start taking withdrawals from the 457b at age 50. I know you can, but 457b usually does not have required minimum distributions until 73, just like a traditional IRA. You can also roll it over to an IRA, but I wouldn’t do that until age 59.5 because you would lose the penalty free withdrawals of the 457b.
3. I am also a little leery that a $2.5m taxable account doesn’t have other dividends, interest, even muni bond interest, that might increase your MAGI.
I’m not saying your withdrawal plan isn’t a good one (to emphasize reducing taxable) but it’s hard to say without an accurate picture of the size of 457b, and later Social Security.
Whether you get an ACA subsidy is rarely the reason for a specific retirement plan.
Awesome! Thanks FinancialDave, this is the kind of feedback I was looking for.
You got my hopes up about being able to defer 457b distributions or roll the 457b into an IRA. However, I got out the plan documents and they clearly state I must take equal installments over either 5 or 10 years, and these must start within 60 days of separation from my employer. It specifically says I can’t roll it into anything but another 457b, and I expect never to have one of those again.
Thanks for the reminder that there are other dividends and interest in taxable. It contains only US and international equities index funds, so the dividends are small, but not zero. I’ll have to keep a close eye on individual tax lots as I sell, so I can keep the MAGI around $53,000.
And I know it seems crazy to be focused on ACA subsidies, but consider that in my state, a MAGI of $53,000 gets me health insurance for $27/year, with an out-of-pocket limit that is less than just the premiums of a private plan. Our income and property taxes are very high here, so it feels great to get something back.
Also thanks for the reminder this will change when I start taking social security and drawing from my 403b. I’ll look into this more. With a little luck I’ll be close to Medicare age when the taxable account runs dry.
It sounds like you have a non-governmental 457b (like I do). Perhaps the governmental flavor has the flexibility he described. Nevertheless, you’ve got the perfect use case for the 457b since you’ll be in such a low tax bracket. How steep is the slope on that ACA subsidy? I wouldn’t want to drain my taxable that fast but maybe it really is your best option.
Yep, it’s non-governmental. I think you’re right that a governmental 457b can be rolled over.
I didn’t think about it when I signed up for the 457b, but it is helpful for early retirement. I actually stopped contributing to it this year because I was worried the required distributions would make my income too high for ACA subsidies. Probably this really is a case of the tail wagging the dog.
Good question on the slope of the subsidy. I know there is no longer a “cliff.” It’s hard to get exact figures on the subsidy without actually applying. I recall it being close to $0 around the $75,000 MAGI level.
It does feel like I’m threading the needle a little close in terms of draining the taxable account over 15 years (if that). But, that’s what it’s for. There’s no room for that money in the casket.
The additional tax protection, asset protection, and tax rate arbitrage is likely to be worth more than the ACA subsidies.
Brian,
Like I said it is really important to know what kind of investments you have in your taxable account(s). Are they stocks generating a lot of dividends or mutual funds?
To assess this, pull out your 2023 1040 and even your 1099B from the taxable brokerage.
On the 1040 look for numbers in boxes 2a, 2b, 3b, and line 7.
3b is really the most important because this is the ordinary income from dividends which drops directly to your AGI, as does 2b. 2a is important too as it is tax exempt interest which is added to your AGI to get MAGI.
On a $2.5m taxable account this 3b number (plus 2b) could be $50k or bigger, meaning you need to replace all or most of the LTCG by spending these dividends. You do that by NOT reinvesting all the dividends but sending them to your MM settlement account, so you can spend them directly from your cash bucket. The same goes for 2b taxable interest. Spending some or all of this will reduce how much other Capital Gains you will need to create. If you own mutual funds you are getting STCG and LTCG and dividends from these funds that you should not be reinvesting as well, so you can spend them.
Doing all the above should reduce the amount of other LTCG you need to generate by selling things, especially in a down market, when you would have to sell more shares.
By comparing your 1040 lines above to your 1099B you can see how much of the above line items are coming from your brokerage or from other high yield savings, etc. 1099b also can show how much of Capital Gains were ST and how much were LT for anything you sold in 2023. You may get a shock in 2024 on how much “stealth” income will still be in your AGI even if you pay little Federal income tax.
If you don’t plan on living off taxable until 2025, you have some time to rearrange where dividends are going and how much you actually have.
The taxable account is $1MM (other $1.5MM is tax-advantaged). It contains only Vanguard total market and Vanguard international index funds. It looks like my dividends from 2023 were $13,000, almost all as qualified dividends. Good to know! I will direct dividends to MM account.
As I understand it, these dividends just mean I will sell fewer equities to keep the taxable withdrawals at $62,000, right?
It looks like I should still qualify for subsidies with this income + 457b income. But I’m starting to get it that I should max out the 457b for the rest of the year and focus more on overall financial picture rather than keeping MAGI low for subsidies, especially given the vagaries of the ACA rules.
Thanks all!
Brian,
“As I understand it, these dividends just mean I will sell fewer equities to keep the taxable withdrawals at $62,000, right?”
Yes, but to say it a different way if you are planning to spend $80k of income (allowing $4k for taxes) you want to spend the income that is already being taxed, such as dividends even if their tax rate is zero, to minimize creating other taxable income.
The dividends on something like VTSAX are around 1.4% and the dividends on International funds are higher – some like 3%. So depending on the split if you have around $1m now in taxable the dividends could be between $15k – $20k. Any cash you have in the Vanguard settlement fund would be earning near 5% interest.
So, say your cash and dividends turn out to be $20k, then you only need to sell $42k in the taxable, which at 50% basis would add $21k of LTCG, giving you an extra margin of safety to ACA subsidy limit, provided the actual 457b withdrawal is $22k.
Brian,
I did my last post in a bit of a hurry, such that when allowing for the dividends that add to your AGI dollar for dollar, you will quickly get over your ACA subsidy, if your cost basis is 50% for LTCG. Your MAGI will be:
$22k (IRA)
$20k (DIV)
$21k (LTCG)
MAGI = $63k
That makes sense. Fortunately, I underestimated my cost basis, which is actually closer to 70%. Using that number gets me back down to MAGI $51k. Thanks again for taking a look.
It’s also important to realize once SS comes into the picture, there really is very little LTCG that is in the zero percent bracket, depending of course on the size of your SS. The more SS, the less you will have in the 0% bracket as SS will be taxed with the addition of LTCG or Dividends, up to it’s 85% taxable limit.
WCI,
“If you are in the 0% LTCG bracket and expect to stay there, there isn’t nearly as much benefit to contributing to retirement accounts at all.”
In what world does contributing to taxable account win out over contributing to Roth – None, as far as I know.
If a person is in the 25% tax bracket and earns $1000 pre-tax and they put either $750 in Roth or $750 in taxable, the Roth is going to win every time, no matter if you are in 0% LTCG bracket or not.
Remember the point about SS being taxed with LTCG, well Roth does not have that problem.
What would be the implications if I had a $25,000 loss (schedule E) from real estate investing? Would this allow me an additional $25,000 in long-term gains at potentially 0%?
Partnership losses on Schedule E are different from capital losses on Schedule C. They’re actually probabely better. You can use them against partnership gains and eventually even ordinary income when the property is sold and the partnership ended.
People should be aware that even though they may be in the low bracket their marginal rate will likely be higher, especially if they are on social security and taking RMD’s. 22% is likely.