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Guaranteed 10-28% Return
Old 03-01-2013, 01:13 PM   #1
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Guaranteed 10-28% Return

Ever heard the adage "Don't let the tax tail wag the investment dog"? IMO, not such good advice for ER's. This topic may be old hat for some of you, but it did not dawn on me until recently.

Our situation: DW will retire next year, I am already retired. I will be 57, DW will be 55. We will have between 5 and 15 years before we collect SS (likely toward the end of that range). We do not have pensions, will have no earned income, and have both taxable and tax deferred investment accounts. Have over $400k in LT cap gains in taxable accounts. We file a joint tax return, take the standard deduction (no mortgage) with 2 exemptions.

Strategy: To the extent that is practical, I will postion my taxable portfolio to "reduce" dividend income starting next year. Then sell enough holdings to generate about $90,000 of capital gains (less the dividends that are distributed during the year). The tax on the CG would be zero as opposed to 15-28% (marginal rates). Do this every year until the CG are mostly exhausted. After that, pull $ from tax-deferred accounts (up to $90k MAGI) of which would be taxed at 15%. Should be able to keep doing this for 15 years, unless the tax laws change.

One recent caveat is the ACA (Obamacare). Might need to keep MAGI below $60k to get larger subsidy on HI, but it still may be more advantagous to take the exta $30k of income with zero CG rate.

Anyone see any holes in this strategy? There must be some, or a lot of people would be doing it (maybe they are?). Thoughts?
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Old 03-01-2013, 03:08 PM   #2
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I'm missing something here. How are you selling 90K worth of LTCG and paying zero tax on that?
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Old 03-01-2013, 03:14 PM   #3
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I don't have that much in CG's, so I'm pretty much starting with Roth conversions instead. All depends on how much you have and where, I think. Pretty much the same, except some early income is mixed CG's and Roth conversion "income". Later on, during RMD's if you still have IRA funds, it's a mix of traditional IRA withdrawals and Roth withdrawals to stay in the 15% bracket.
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Old 03-01-2013, 03:17 PM   #4
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I'm missing something here. How are you selling 90K worth of LTCG and paying zero tax on that?
Does seem like a lot, but as long as it's generally within the 15% tax bracket it's a 0% tax rate. $90k might be possible with some deductions.
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Old 03-01-2013, 03:31 PM   #5
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If the LTCG cashed out, when included in the total taxable income, is still less than $70700 for a couple filing a joint return, aren't they are still within the 15% tax bracket that has no long term capital gain obligation? So if there are other deductions that kept the taxable income below the threshold, would his math work?
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Old 03-01-2013, 03:32 PM   #6
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I'm with you - I may be tax gain harvesting my first years of FIRE to make sure I hit the right AGI for Obamacare, and to use up some low/no tax brackets. Or some Trad IRA to Roth conversions. Or both.
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Old 03-01-2013, 03:41 PM   #7
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OK did a little research and found that CG are taxed based on Ordinary Income tax bracket. If retired with no Ordinary Income (defined as wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, or dividends), am I to understanding that you could theoretically sell out on the entire 400K LTCG and pay no tax on it?
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Old 03-01-2013, 03:56 PM   #8
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This all leads to a question regarding Capital Gains in a 401K. Are distributions broken out as part tax-deferred ordinary income taxable at the current income level and capital gains? This would be a good thing and significantly reduce the tax required on 401K distributions as you could limit your distributions to the 10-15% tax bracket and avoid tax on the gain portion.
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Old 03-01-2013, 03:57 PM   #9
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OK did a little research and found that CG are taxed based on Ordinary Income tax bracket. If retired with no Ordinary Income (defined as wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, or dividends), am I to understanding that you could theoretically sell out on the entire 400K LTCG and pay no tax on it?
Since you have done the research, will Social Security benefits be counted as income to calculate the income tax bracket? Will the amount you take in from LTCG count towards calculating the modified adjusted gross income? What I am asking is, do you need to delay taking out Social Security benefits until you can cash out all the LTCG with no tax on them?
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Old 03-01-2013, 04:30 PM   #10
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Since you have done the research, will Social Security benefits be counted as income to calculate the income tax bracket? Will the amount you take in from LTCG count towards calculating the modified adjusted gross income? What I am asking is, do you need to delay taking out Social Security benefits until you can cash out all the LTCG with no tax on them?
Yes, I believe SS is counted as income and taxed depending on how much "provisional income" you have. This is all other income sources included tax-exempt income. There is a base amount below which SS is not taxed...ah hell it's complicated...here's a link

Social Security: Taxable Portion of Social Security Benefits
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Old 03-01-2013, 04:45 PM   #11
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Originally Posted by Packman View Post
Ever heard the adage "Don't let the tax tail wag the investment dog"? IMO, not such good advice for ER's. This topic may be old hat for some of you, but it did not dawn on me until recently.

Our situation: DW will retire next year, I am already retired. I will be 57, DW will be 55. We will have between 5 and 15 years before we collect SS (likely toward the end of that range). We do not have pensions, will have no earned income, and have both taxable and tax deferred investment accounts. Have over $400k in LT cap gains in taxable accounts. We file a joint tax return, take the standard deduction (no mortgage) with 2 exemptions.

Strategy: To the extent that is practical, I will postion my taxable portfolio to "reduce" dividend income starting next year. Then sell enough holdings to generate about $90,000 of capital gains (less the dividends that are distributed during the year). The tax on the CG would be zero as opposed to 15-28% (marginal rates). Do this every year until the CG are mostly exhausted. After that, pull $ from tax-deferred accounts (up to $90k MAGI) of which would be taxed at 15%. Should be able to keep doing this for 15 years, unless the tax laws change.

One recent caveat is the ACA (Obamacare). Might need to keep MAGI below $60k to get larger subsidy on HI, but it still may be more advantagous to take the exta $30k of income with zero CG rate.

Anyone see any holes in this strategy? There must be some, or a lot of people would be doing it (maybe they are?). Thoughts?

After an hour of research, I see no holes in your strategy and thanks for bringing it to the table. Wasn't aware of this play on the tax system.

Good luck.
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Old 03-01-2013, 04:56 PM   #12
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We have 109K (today) in gains across three funds that we intend to realize and pay zero taxes on. It will probably take about three years. Most other funds have gains of < 5K, so unless those take off we won't bother with them.
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Old 03-01-2013, 05:26 PM   #13
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Originally Posted by NanoSour View Post
OK did a little research and found that CG are taxed based on Ordinary Income tax bracket. If retired with no Ordinary Income (defined as wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, or dividends), am I to understanding that you could theoretically sell out on the entire 400K LTCG and pay no tax on it?
Incorrect Tax Calculator - Estimate Your Income Tax for 2012 and 2013

I think many of us are trying to fill the 15% $ threshold with any combination of income, dividends, CG, etc. while the tax benefit still exists - without going over.
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Old 03-01-2013, 05:27 PM   #14
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Anyone see any holes in this strategy? There must be some, or a lot of people would be doing it (maybe they are?). Thoughts?
I don't see any major flaws in your strategy, and I think a lot of people are using it. The 0% tax rate on long term capital gains is just too tempting to ignore.

The one obvious problem with the strategy that you outline is that you probably shouldn't focus soley on generating capital gains, to the exclusion of taking distributions from your tax deferred accounts. If you have nothing but capital gains and qualified dividends in a given year, you won't be taking full advantage of the portion of your income that is taxed at 0% or 10%. If I am reading the tax tables correctly, a married couple currently gets a standard deduction and two exemptions worth $20,000 of tax free income plus another $17,850 of income taxed at 10%. You should be looking at ways to take at least $20,000 and up to $37,850 from your 401k on the likelihood that it will never be taxed at a lower rate. Only after you have withdrawn that much from your 401k should you turn your attention to generating long term capital gains up to the limit of the 15% tax bracket.

Of course you are not yet 59 1/2, so you have to be careful not to trigger the 10% early withdrawal penalty. Otherwise you're in great shape. You can look forward to many years of essentially tax free income.
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Old 03-01-2013, 05:47 PM   #15
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Paying expenses with a taxable account while paying no taxes AND converting 401(k)/IRA to a Roth IRA is a well-honed technique around here. There are a number of posts on the subject. Most of those posts talk about using the calculator at www.i-orp.com and confirming the taxes with TurboTax.

See also Bogleheads &bull; View topic - How to pay ZERO taxes in retirement with 6-figure expenses

Many folks simply refuse to believe that this is possible, so they don't even bother to look at their own personal situation to see if they can make it work. Not my problem.
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Old 03-01-2013, 05:50 PM   #16
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If applicable don't disregard state income state. State taxes can foul up an otherwise perfect plan.

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Old 03-01-2013, 06:31 PM   #17
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As the original poster, I should have explained the math. Capital gains are taxed at 0% if you are in the 15% income tax bracket. If I have $90 in MAGI, and have about $20k in the standard deduction and exemptions, my taxable income is around $70k, which is the top of the 15% tax bracket. So no tax on LTCG. However, if I pull from the taxable IRA's up to 90k, I pay 15% tax (marginal rate). My thought is to use the cap gains first, pay no tax, then start pulling the deferred money. All the while my SS payments get larger, providing me with a form of long term care insurance - instead of paying irrationally high premiums to insurance companies.

Everyone's situation is different depending on how much you have in these buckets. But the point is, there are ways to pay little to no tax after ER, so make sure you check it out. Where else are you going to get this kind of guaranteed return?

One other misnomer - "only invest in Roth IRA's, as taxes are certain to go up in the future". 47% of American's pay no federal income tax at all. Taxes only go up in the upper brackets.
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Old 03-01-2013, 06:44 PM   #18
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Originally Posted by NanoSour View Post
This all leads to a question regarding Capital Gains in a 401K. Are distributions broken out as part tax-deferred ordinary income taxable at the current income level and capital gains? This would be a good thing and significantly reduce the tax required on 401K distributions as you could limit your distributions to the 10-15% tax bracket and avoid tax on the gain portion.
Nano... I believe that all distributions from a 401(k) are taxed as ordinary income - no "CG" passes thru.
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Old 03-01-2013, 07:05 PM   #19
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Thanks for posting that calculator. I did a search and saw that pub4uski had also pointed out a useful tax estimation calculator. I am beginning to understand what needs to be done. When your harvested LTCG boosted the modified adjusted gross income level so 85% of social security benefits will be taxed, the benefits from Social Security then add to the gross and taxable income.

To put it in actual numbers , if the regular tax income is $15000 a year in 2013, and LTCG is $31000, a single person pays $500 on the regular income and $0 tax on LTCG.
But if you start to collect $20000 in social security benefits in 2013, 85% of that will become taxable because the modified gross median income is $56000 ( gross income + 1/2 of SS). Not only did income tax get boosted to $2850, but there is a $2513 tax on the LTCG as well. The $20000 Social Security benefits net you only $ 15137 after tax.

My take is that one should delay taking SS until the LTCG had been realized.
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Old 03-01-2013, 07:16 PM   #20
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OK did a little research and found that CG are taxed based on Ordinary Income tax bracket. If retired with no Ordinary Income (defined as wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, or dividends), am I to understanding that you could theoretically sell out on the entire 400K LTCG and pay no tax on it?
no, this is not correct.

Ha
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