Tax question for withdrawal

[Hokie]

Im trying to map out and understand a few things. Goal is Retire by age 50. I will use taxable investment account with Vanguard for withdrawal from age 50 through age in which I can access qualified retirement accounts. What I am trying to understand is how my withdrawals during this 10+ year period will be taxed. So hypothetically if the account is $1Million at age 50.....$500k are my after tax contribution $500K are gains.....At this point I retire with $0 annual income. I withdraw $40K/ year. What is my tax liability on the $40k? I have read so much on this that Im not sure because some of the info contrdicts other info. Is the withdrawal a mix of my contributions(already taxed) and the gains(not yet taxed)? If so, would that mean$20k of my $40k is subject to capital gain taxes? Then I read that married couples filing jointly with less than $70kish combined income are not subject to capital gain taxes Did I misread or misunderstand that? If that is the case, our combined income is essentially $0 at that point so does that mean $0 tax on the withdrawal? I dont think so but trying to figure it all out. Any help in clearing this up for me would be appreciated. Thanks!

 

[audreyh1]

Taxable investment account:

Only gains are taxed (assuming you have no dividends or distributions)

When you sell a security, you subtract the cost basis (what you paid for it) from the sale proceeds. This resulting capital gain is treated as long-term capital gain income.

So, if you sell $40K of taxable investments, and your cost basis was $20K, you are only looking at $20K of long-term capital gains income.

Long-term capital gain income is taxed at 0% for singles up to around $37K and married filing jointly up to around $77K. It’s actually quite a bit higher than that when you add the on the standard deduction.

So if your gains are $20K, you are looking at 0% tax unless you have other taxable income that year.

You can also reduce taxes by selling securities with the highest cost basis. Complicates things, but might be worth it depending on the circumstances.

 

[pb4uski]

Your withdrawal will be accomplished by selling shares.... and that sale will trigger gains ... $20k in your case... but the LTCG tax rate at the level of income that you indicate is 0%... so you tax bill on those $40k of withdrawals will be $0.

What you should consider is doing Roth conversions while your tax rate is low. Over the last 5 years, I converted ~$260k and have paid ~$19k (7.3%) in federal tax.... much lower than the 28%+ that I avoided when I deferred that income or the 22%+ that I would expect to pay if I continued deferring it and withdrew it later once SS has started.

Or alternatively you can do some "gains trading"... sell and buy the same or similar security to use up the 0% tax bracket on gains... these shares then have a higher basis so when you sell them later to use the money the gain will be less... its a no brainer if you have room in the 0% gains and are not doing Roth conversions.

 

[VanWinkle]

Im trying to map out and understand a few things. Goal is Retire by age 50. I will use taxable investment account with Vanguard for withdrawal from age 50 through age in which I can access qualified retirement accounts. What I am trying to understand is how my withdrawals during this 10+ year period will be taxed. So hypothetically if the account is $1Million at age 50.....$500k are my after tax contribution $500K are gains.....At this point I retire with $0 annual income. I withdraw $40K/ year. What is my tax liability on the $40k? I have read so much on this that Im not sure because some of the info contrdicts other info. Is the withdrawal a mix of my contributions(already taxed) and the gains(not yet taxed)? If so, would that mean$20k of my $40k is subject to capital gain taxes? Then I read that married couples filing jointly with less than $70kish combined income are not subject to capital gain taxes Did I misread or misunderstand that? If that is the case, our combined income is essentially $0 at that point so does that mean $0 tax on the withdrawal? I dont think so but trying to figure it all out. Any help in clearing this up for me would be appreciated. Thanks!

Under current tax laws, you can take capital gains up to 77,200 plus 24,000

standard deduction for married filing joint for a total of 101,200 in income

with a "zero" tax rate. All of the income would have to be capital gains and

qualified dividends for this to work.

 

[RE2Boys]

The gains may be taxable by your state.

 

[RunningBum]

Agree with all of the above. Don't forget that you probably have some dividend and interest income. All that income, less deductions and exemptions, have to be under that $37k/$72k cap for CGs and Divs to be at the 0% rate. By all means take advantage of this window for doing Ruth conversions or 0% CG harvesting.

 

[gauss]

You may wish to get some income tax software and play around with it to feel more comfortable with this.

Just understand that there were significant tax changes that went into effect beginning in 2018.

Another tactic may be to make an actual small withdrawal now of the kind you plan to do after retirement. You can then familiarize yourself with the tax ramifications / paperwork etc during the course of the next year when you actually file this years taxes.

-gauss

 

[SkinsFan0521]

Hi,

I have a similar question to the OP and my plan for FIRE is also very similar (retire no later than 50 and live off a brokerage account until 59 1/2).

Let's use a slightly different scenario for what is contributions vs gains:
$1m total portofolio
$250k are contributions and $750k are gains
Married filing jointly
Want to withdrawal $100k/yr
Each year it comes out as $25k in contributions and $75k in gains

I understand that with the standard deduction the LTCG rate is $0 up to the $102k. What I'm confused about is if the $25k counts at all towards that $102k? Is that $25kjust "tax free" and not even something that is considered as part of the calculation to determine your tax bracket? If that's the case, my "income" would be $75k and all at 0%? So, then I could actually withdrawal an additional $27k tax free?

Thanks!

 

[ocean view]

Hi,

I have a similar question to the OP and my plan for FIRE is also very similar (retire no later than 50 and live off a brokerage account until 59 1/2).

Let's use a slightly different scenario for what is contributions vs gains:
$1m total portofolio
$250k are contributions and $750k are gains
Married filing jointly
Want to withdrawal $100k/yr
Each year it comes out as $25k in contributions and $75k in gains

I understand that with the standard deduction the LTCG rate is $0 up to the $102k. What I'm confused about is if the $25k counts at all towards that $102k? Is that $25kjust "tax free" and not even something that is considered as part of the calculation to determine your tax bracket? If that's the case, my "income" would be $75k and all at 0%? So, then I could actually withdrawal an additional $27k tax free?

Thanks!

You are taxed on income/earnings. In your scenario $25k is neither of these things. It is a return of your investment. Not taxable and not included in the $102k in your example.

Think of it on a smaller scale, you put $25 cash in a savings account and 30 years later the balance was $100 and you withdrew all of it. Only the growth from $25-100 in earnings is taxable income, the rest is just taking back possession of your property, cash.

 

[SkinsFan0521]

You are taxed on income/earnings. In your scenario $25k is neither of these things. It is a return of your investment. Not taxable and not included in the $102k in your example.

Think of it on a smaller scale, you put $25 cash in a savings account and 30 years later the balance was $100 and you withdrew all of it. Only the growth from $25-100 in earnings is taxable income, the rest is just taking back possession of your property, cash.

Ok, thanks for your quick response. That's what I thought, but I just wanted to be sure. I've never actually taken money out of any of my accounts so I'm not familiar with that strategy. haha

Thanks again!

 

[audreyh1]

Hi,

I have a similar question to the OP and my plan for FIRE is also very similar (retire no later than 50 and live off a brokerage account until 59 1/2).

Let's use a slightly different scenario for what is contributions vs gains:
$1m total portofolio
$250k are contributions and $750k are gains
Married filing jointly
Want to withdrawal $100k/yr
Each year it comes out as $25k in contributions and $75k in gains

I understand that with the standard deduction the LTCG rate is $0 up to the $102k. What I'm confused about is if the $25k counts at all towards that $102k? Is that $25kjust "tax free" and not even something that is considered as part of the calculation to determine your tax bracket? If that's the case, my "income" would be $75k and all at 0%? So, then I could actually withdrawal an additional $27k tax free?

Thanks!

That $25K is your cost basis, the money originally invested which you got back after selling the asset. It doesn't count as income in any way.

 

[audreyh1]

You are taxed on income/earnings. In your scenario $25k is neither of these things. It is a return of your investment. Not taxable and not included in the $102k in your example.

Think of it on a smaller scale, you put $25 cash in a savings account and 30 years later the balance was $100 and you withdrew all of it. Only the growth from $25-100 in earnings is taxable income, the rest is just taking back possession of your property, cash.

Just to be clear - in the savings account scenario you will be paying taxes on your interest income every year during those 30 years except for the case of iBonds.

So when you pull money out of a savings account, it is not a taxable event, and you aren't selling an appreciated asset. Receiving the interest on your savings account is the taxable event.

 

[pb4uski]

Usually when you are selling shares on your brokerage's website it will tell you what your realized gain will be. You'll also want to be sure to select the specific identification method so you can control what your gains are.

We are living off of taxable account funds too. Our income is dividends and capital gains. Qualified dividends and long-term capital gains are 0% because we manage our income to stay in the 12% tax bracket. Non-qualified dividends and short-term capital gains are at ordinary tax rates but are offset by standard deductions..... so before Roth conversions, our tax is $0.

 

[karen1972]

Also, remember every year you re-invested your cap gains/div, you paid taxes in that year on those extra shares so you increased your cost basis.

When you sell your shares, you can also select cost basis which can be very beneficial if you want to be more creative in your tax planning.

 

[ocean view]

Just to be clear - in the savings account scenario you will be paying taxes on your interest income every year during those 30 years except for the case of iBonds.

So when you pull money out of a savings account, it is not a taxable event, and you aren't selling an appreciated asset. Receiving the interest on your savings account is the taxable event.

Good point. I guess I tried to simplify and instead made it messy. Thanks for cleaning up after me.

 

[trirod]

Also don't forget that in your example of selling 100k in stock and realizing 75k in gains is based on the average unrealized gain in your portfolio. By selecting which stock you sell, you can have a lot of control over how much gain you realize. Typically the stock you've held the longest will have the highest unrealized gain, so if you want to generate less taxable income in a given year you can choose to sell more recently acquired stocks.

If you have a $1,000,000 taxable portfolio then you are likely generating around $20,000 of dividends each year, and these count towards your tax free space too.

 

[pb4uski]

Hi,

I have a similar question to the OP and my plan for FIRE is also very similar (retire no later than 50 and live off a brokerage account until 59 1/2).

Let's use a slightly different scenario for what is contributions vs gains:
$1m total portofolio
$250k are contributions and $750k are gains
Married filing jointly
Want to withdrawal $100k/yr
Each year it comes out as $25k in contributions and $75k in gains

I understand that with the standard deduction the LTCG rate is $0 up to the $102k. What I'm confused about is if the $25k counts at all towards that $102k? Is that $25kjust "tax free" and not even something that is considered as part of the calculation to determine your tax bracket? If that's the case, my "income" would be $75k and all at 0%? So, then I could actually withdrawal an additional $27k tax free?

Thanks!

Probably not, because you need to consider other income that you have. The 2018 limit for 0% qualified dividends and LTCG is $77.2k... add $24k for standard deductions and that is $101.2k.

Let's say that your portfolio generates $18k of qualified dividends... that leaves $83.2k... and after your $75k gain relating to your withdrawal for living expenses that leaves you with $8.2k.

You can fill that $8.2 k with $10.9k of taxable account sales resulting in $8.2k gain...you can even buy back the same stock and increase your basis at $0 tax cost... aka gains trading (no prohibition on wash sale gains... only wash sale losses).... or if you have a tIRA you could do a $8.2k Roth conversion at $0 cost.

 

[SkinsFan0521]

Thanks for the replies pointing out the dividend income as well. Makes sense, but that's also tax free (in the lower tax brackets), right? So, I'd actually be withdrawing less, but same end result of actually being able to spend more than the $102k and have it still be tax free:

$25k of principle
+ $75k of LTCG
+ $20k of qualified dividends
= $125k of "spending" money without paying any tax $$ and still actually have $7k+ of available room in the tax bracket

Then, if I were to do a Roth conversion for that $7k (or earned income from a side hustle, etc.) I'd only owe 15% tax on the $7k, right?

Does that math look right?

Thanks again for all the help!

 

[pb4uski]

No, the $7k (actually $6.2k) would also be tax free because of itemized deductions.

Dividends...... $20.0k
LTCG............. 75.0k
Other income.. 6.2k (side hustle, Roth conversions or additional inv gains)

Total income....101.2k
Deductions...... (24.0k)

Taxable income.. 77.2k

Ordinary inc..... (17.8k) therefore no tax
LTCG/div inc...... 95.0k 0% tax
Taxable income.. 77.2k

So could spend up to $126.2k tax free... $100k withdrawal + $20k dividends + $6.2k other income.

Note if the other income is a side hustle then it might be subject to self-employment tax (15.3%) even though it is not subject to income tax.

 

[audreyh1]

Are you getting any interest income from your checking or savings accounts? That will count as ordinary income.

 

[SkinsFan0521]

@pb4uski - Thanks, got it!

@audreyh1 - Good point. Thanks!

We're still a long ways away from FIRE (34 now, hoping to RE between 45 & 50), so I understand tax laws could change and the current tax laws will be expired by then, etc. I just want to be sure that I understand how it all works now so I can plan accordingly and make adjustments as we get closer and things change. Really, the thing that we need to focus on to get us to be able to retire as early as possible is the brokerage account. We have very little in ours right now, but max out Roth 401k and Roth IRA and HSA. I need to be sure that we focus on building up that brokerage account ASAP and, now that I understand how it's all taxed, it will make it easier to come up with a target number that will provide us the spending level that will get us through that 10-15 years between ER & 59 1/2.

Thanks again for all the help!

 

[Rustward]

There is a subtle difference between "tax free" and "taxed at 0%", but in some cases it really does matter.

 

[karen1972]

I need to be sure that we focus on building up that brokerage account ASAP and, now that I understand how it's all taxed, it will make it easier to come up with a target number that will provide us the spending level that will get us through that 10-15 years between ER & 59 1/2.

Thanks again for all the help!

Yes THIS!!! I think it changes everything because when you talk about "taxable" account I always pictured 35% Fed taxes and whoa is me the govt is taking all my money.. once I realized NO, almost all the money I put into those accounts are already taxed and with planning will never be taxed again, it changed everything.

Also things to remember while you build up that taxable brokerage
1. Tax harvesting every year... this is something I should have done more of. It would have increased my current cost basis significantly.
2. I would have invested differently as I had some high dividend yielding funds in my taxable account which was just stupid to pay taxes on those while working.

Basically I did a horrible job managing my taxes while growing that taxable account; hopefully you will do way better.

 

[MBAustin]

For cost basis, you'll need your year-end statements for every year before 2012 when the cost basis tracking became the responsibility of the fund. So you may want to dig through your old paperwork now and build a spreadsheet showing what dividends and CGs were reinvested, because you already paid taxes on them. I did that several years ago for funds I had purchased in the 80's and 90's and it was a real PITA, but it made it clear which ones I could easily sell (low or no actual tax liability) and those with enormous unrealized gains that would be a serious tax hit. Those are going into a donor advised fund for our ongoing charitable deductions.

If you are missing a statement or two (as I was) you can generally recreate the info in the gaps using historical price info (I used Yahoo) and the records of the fund company.

 

[UtahSkier]

Im trying to map out and understand a few things. Goal is Retire by age 50.

Practice, Practice, Practice!

Model your retirement situation (I use quicken) and then use your favorite tax program to understand the dynamics of the many tax decisions you will need to make. You gotta know the rules.

For 2017, my income (1040 - line 22) is $69K. My tax owed (line 63) is $55. And my DW and I get $1300 a month in Obamacare subsidy.

The income was from CG ($16K), Divs and Interest ($31K), and 401K income($22K). My living expenses are nearly double what my income is. So yes, I am drawing down a taxable account.

One more thing. Before DW and I retired, I anticipated the need to meet the tax rules for Obamacare subsidies. I re-balanced my AA and greatly increased my portfolio's cost basis.

This way, I can harvest CGs to generate cash and pay a minimum of federal tax.