Taxation of LTCGs during retirement

[TheWizard]

Definitely letting the tax tail wag the dog here...

 

[TheWizard]

12% * 85% since each $1 of 0% LTCG causes 85c of SS to become taxable at 12%.

Taxation of SS income goes from 0% to 50% to 85% taxable, not from 0% to 85% in one step.
There is a mistake here somewhere...

 

[SevenUp]

12% * 85% since each $1 of 0% LTCG causes 85c of SS to become taxable at 12%.

Taxation of SS income goes from 0% to 50% to 85% taxable, not from 0% to 85% in one step.
There is a mistake here somewhere...

With the right combination of SS benefits, ordinary income, and capital gains, an additional $1000 of LTCG can incur no tax itself, but cause $850 of SS to become taxable, incurring $850 * 12% = $102 tax.

$102/$1000 is a 10.2% marginal tax rate on the LTCG income.

 

[Sandy & Shirley]

Thanks to everyone for their advice, it has helped us make our final plans.

We will start our standard brokerage accounts as soon as possible and we will track our investment dates and amounts on a spreadsheet. Hopefully all of the investments will grow into capital gains, but we know that some will probably result in short term losses. Near the end of each year, we will generate the necessary short term gains to offset the losses, then take as many long term gains as we can while remaining below the point where those gains will become taxable. If we still have room for more pre 22% (40.1% marginal) income, we will withdraw what we can and move the cash into our standard account, and, if the market seems right, invest it.

Basically we are creating an account that is in the middle of an IRA and a Roth. Most of the assets in the account will be tax free return of capital while all of the matching short term gains and losses will be tax free transitions while almost all of the future growth will be limited to 10.2% Federal Taxes.

 

[WhenIsItTime]

Definitely letting the tax tail wag the dog here...

Thanks to everyone for their advice, it has helped us make our final plans.

We will start our standard brokerage accounts as soon as possible and we will track our investment dates and amounts on a spreadsheet. Hopefully all of the investments will grow into capital gains, but we know that some will probably result in short term losses. Near the end of each year, we will generate the necessary short term gains to offset the losses, then take as many long term gains as we can while remaining below the point where those gains will become taxable. If we still have room for more pre 22% (40.1% marginal) income, we will withdraw what we can and move the cash into our standard account, and, if the market seems right, invest it.

Basically we are creating an account that is in the middle of an IRA and a Roth. Most of the assets in the account will be tax free return of capital while all of the matching short term gains and losses will be tax free transitions while almost all of the future growth will be limited to 10.2% Federal Taxes.

I don't understand the strong focus on realizing CG's and creating tax events.

Unrealized CG's is an obvious goal for any investor. Most would suggest CG(L) causing assets are best for long term (greater than 3 years) investors.

If you have estate plans to pass wealth forward, any CG below the threshold passes tax free.

I've never heard of one that involves recognizing CG(L) routinely as a strategy. Is this something that was recommended to you or are you creating?

 

[Sandy & Shirley]

Is this something that was recommended to you or are you creating?

Actually, it is something that we are in the process of creating.

We are a domestic couple, 75 and 67, and we will be paying off our mortgage this year. Our current mortgage payment is $1,500 monthly, $18,000 a year. We currently have to withdraw $25,696 a year and pay 22.2% Federal and 7.75% State tax to end up with the extra $18,000 for the Mortgage.

We are currently making those withdrawals within what we call our Marginal Tax Hump, where our 12% (22.2%) Federal tax rate jumps to 22% (40.7%) tax rate until 85% of our Social Security has been taxed.

This is what I created as a computer/math geek.

The taxes due in our current tax graph, where the red tax line stays at 22.2%, is $4,907. If we can use the extra, post mortgage payments, income to create standard brokerage accounts, we can start creating the 10.2% tax dip for both of us for an eventual $1,200 tax savings for each of us.

We realize that the Government spent a lot of time and effort in 1993 when they created the 85% taxation rate for our Social Security benefits. And a lot retired individuals believe that they deserve all the extra tax revenue that we can give them! Maybe we are just stingy with the money we worked hard for and saved for our retirement and we don’t want to just give our hard earned money back to them!

So, yes, this is something that I created, and it is something I plan to start building for us as soon as our final mortgage payment is made!

 

[SecondCor521]

I've never heard of one that involves recognizing CG(L) routinely as a strategy. Is this something that was recommended to you or are you creating?

Not the OP, but the ideas of both "capital gain harvesting" and "capital loss harvesting" have been around before OP thought about it.

Because stocks "usually" go up and are currently taxed better than ordinary income, they are ideas that people will eventually come across when they start looking at taxes.

Lots of different thoughts and strategies in this area. Which one is best sort of depends on the totality of the financial and tax situation of the taxpayer(s).

 

[SecondCor521]

We will be making smaller and smaller 22.2% IRA withdrawals each year while creating larger and larger 10.2% LTCGs as our Tax Free (return of capital) investments grow.

Emphasis added. Some food for thought:

At some point, your and your partner's RMDs will prevent you from making those "smaller and smaller" IRA withdrawals, and the totals of those RMDs will be enough to where you won't need to even bother realizing those 10.2% LTCGs (because it will be unneeded income). That point will depend on how much you spend, how old you are, and how big your IRAs are.

Less likely based on how you describe your situaution, but you might also hit a point where those forced RMDs plus taxable SS puts you in a higher bracket than 22.2%. Maybe not. Again, it depends on the size of your IRAs and your respective ages. But if this is a possibility, it might make sense to make even larger IRA withdrawals now. Whether to do that from the 75 year old's IRA or the 67 year old's IRA is yet another question to consider.

HTH.

 

[Sandy & Shirley]

Thanks for the food SecondCor521, but I have been nibbling on it for a while!

My partner is a widow with 84% of her IRA in Roth. When she turns 70 her survivor SSB will almost double as her personal SSB and her Traditional IRA will be zero. We are also working on her Annuity income to be about twice mine. Her window for a standard brokerage account will be smaller, but RMDs will definitely not be an issue after age 70.

My Roth is a little over 50% of my holdings, and my smaller Annuity will give us more room for a standard brokerage account. And, yes, RMDs could become an issue as time moves forward. But most of the value in the account will be tax free “return of capital” which can easily be transferred into her account as time progresses.

 

[Out-to-Lunch]

T When she turns 70 her survivor SSB will almost double as her personal SSB and her Traditional IRA will be zero.

You lost me here. Why would her survivor benefit change when she turns 70?

 

[Sandy & Shirley]

As a widow, you can start taking your late husband's Social Security as early as age 60, then you can stop the "survivor" benefits anywhere from age 62 to 70 and start taking your own benefits.

 

[Out-to-Lunch]

Okay, I see. I believe that it was just an inartful phrasing in the post that I quoted; it stated that the survivor benefit would change, but that wasn't exactly what you meant.

 

[sengsational]

Definitely letting the tax tail wag the dog here...

For many folks, it's a simple way to reduce the overall tax rate. "Optimizing" this aspect of federal taxation isn't easy, or even advisable, but taking advantage of at least some of the lower rate probably doesn't require doing anything that would have one deviating from their asset allocation targets. If things went up, you sell enough of the fund to generate the income to fill the need, and in the next minute you buy a similar fund. They're all very highly correlated. Not that hard, and doesn't change the investment profile.

 

[WhenIsItTime]

For many folks, it's a simple way to reduce the overall tax rate. "Optimizing" this aspect of federal taxation isn't easy, or even advisable, but taking advantage of at least some of the lower rate probably doesn't require doing anything that would have one deviating from their asset allocation targets. If things went up, you sell enough of the fund to generate the income to fill the need, and in the next minute you buy a similar fund. They're all very highly correlated. Not that hard, and doesn't change the investment profile.

Why does this seem super ironic to me? Somebody is trying to reduce taxes by realizing gains to fill tax brackets requiring tax payments. After paying the tax, you have less to invest.

Why not just leave low basis assets invested? Unlike Charles Barkley, I hope to have assets remaining in my estate when I die. Wouldn't my lifetime effective tax rate be less if I deferred as much gain as possible to transfer tax free? When I need money now, one consideration I use is to consume financial assets that have a high basis to pay less tax now.

If I need money to pay bills, I would have that in a less risky asset.

This seems to suggest somebody is planning to pay tax on all their unrealized gains before the end of the game (death? running out of money?).

 

[SecondCor521]

Why does this seem super ironic to me? Somebody is trying to reduce taxes by realizing gains to fill tax brackets requiring tax payments. After paying the tax, you have less to invest.

Why not just leave low basis assets invested? Unlike Charles Barkley, I hope to have assets remaining in my estate when I die. Wouldn't my lifetime effective tax rate be less if I deferred as much gain as possible to transfer tax free? When I need money now, one consideration I use is to consume financial assets that have a high basis to pay less tax now.

If I need money to pay bills, I would have that in a less risky asset.

This seems to suggest somebody is planning to pay tax on all their unrealized gains before the end of the game (death? running out of money?).

Cap gain harvesting relies on two things: the availability of the 0% cap gains bracket, and the premise / assumption / determination that one will be realizing that cap gain later.

If one can't use the 0% bracket (a high W-2 earner, for example), or does not expect to realize the cap gain later (a multimillionaire on hospice, for example), then cap gain harvesting would be unadvisable.

It's a tax strategy. Like most tax strategies, it works in some situations and not in others.

 

[Dash man]

Cap gain harvesting relies on two things: the availability of the 0% cap gains bracket, and the premise / assumption / determination that one will be realizing that cap gain later.



If one can't use the 0% bracket (a high W-2 earner, for example), or does not expect to realize the cap gain later (a multimillionaire on hospice, for example), then cap gain harvesting would be unadvisable.



It's a tax strategy. Like most tax strategies, it works in some situations and not in others.

I realized gains to pay living expenses not covered by other income. I just this week sold $31k in stocks with $18k in gains to pay my quarterly estimated Federal taxes for a Roth conversion. Those gains were offset by short term losses I took and reinvested into a different stock. There are lots of different strategies and I don’t know why you’d say it’s unadvisable.

 

[TheWizard]

For many folks, it's a simple way to reduce the overall tax rate. "Optimizing" this aspect of federal taxation isn't easy, or even advisable, but taking advantage of at least some of the lower rate probably doesn't require doing anything that would have one deviating from their asset allocation targets. If things went up, you sell enough of the fund to generate the income to fill the need, and in the next minute you buy a similar fund. They're all very highly correlated. Not that hard, and doesn't change the investment profile.

I basically agree, but only for folks with low enough income to have a good amount of LTCGs taxed at 0%.
And it has nothing to do with needing current income from the appreciated security.
And.....you can buy the SAME security back minutes later at the higher price level if you want...

 

[Sandy & Shirley]

We are looking at this as a way to open a third brokerage account.


Our Roth account is growing tax free, everything we take out of the account is also tax free, but we have to pay full taxes on anything we put into the account, Roth Conversions.


Our traditional IRA account is growing tax free, and everything we take out of the account if fully taxable.


Our third account will be a standard brokerage account. Whatever we transfer into the account from our IRA will be fully taxable, hopefully at a 22.2% marginal tax rate. If we can work out the LTCG situation each year, it will grow at a 10.2% marginal tax rate, and for the most part whatever we take out of the account will be tax free (return of capital).

 

[SecondCor521]

I realized gains to pay living expenses not covered by other income. I just this week sold $31k in stocks with $18k in gains to pay my quarterly estimated Federal taxes for a Roth conversion. Those gains were offset by short term losses I took and reinvested into a different stock. There are lots of different strategies and I don’t know why you’d say it’s unadvisable.

I said it was unadvisable in certain situations. Those situations are not yours, but do exist for some other people.

Evidently it works in your situation, and I'm happy that it does.

 

[COcheesehead]

I took all the cap gains out of my taxable accounts at 0% utilizing gain vs loss harvests and using the down markets of 2018/2020/2022. Everything in my taxable accounts today earns tax free treatment at this point.

 

[scrabbler1]

In one of my first years of ER (2009-2011), before the policies offered by the ACA's exchanges became available, I was paying a lot for my HI. In one of those years, my actual QD/LTCGs exceeded my estimates. I went to my income tax spreadsheet and replaced the estimate with the new, higher number. I will still safely within the 0% federal income tax bracket for this income, so I did not expect my income tax liability to change.

But it did. It went up a little bit. It wasn't due to rounding. It increased because it still counted as income in the medical deductions section of Schedule A. The 7.5%-of-AGI amount rose slightly, so my deductible medical expenses fell slightly, increasing my taxable income slightly. This told me that the 0% bracket wasn't quite always 0%. My state taxes also rose (no preferential treatment for QD/LTCG), but I knew that was going to happen.

 

[rmcelwee]

We are going to pay off our mortgage this year, so, we are thinking about starting a standard brokerage account for the creation of LTCGs. As we understand it, LTCGs are tax free income as long as we are in the 12% Federal tax bracket.

Just a couple points:
1) The tax free thing is based on a $ amount, not a tax bracket. This may change in the future.

2) We sold $85K in stocks on 1/3/22. $83.5K was LTCG. I knew it was Fed Tax free but I completely forgot about state taxes. I grossly underpaid and will be receiving a bill from South Carolina with fines and fees at some point. Don't be dumb like I was...

 

[Rianne]

Just a couple points:
1) The tax free thing is based on a $ amount, not a tax bracket. This may change in the future.

2) We sold $85K in stocks on 1/3/22. $83.5K was LTCG. I knew it was Fed Tax free but I completely forgot about state taxes. I grossly underpaid and will be receiving a bill from South Carolina with fines and fees at some point. Don't be dumb like I was...

And that's why we have an accountant. Worth the $400 IMO. Every state has different tax laws that change yearly. I don't know enough to keep up with that. Plus federal law changes too.

 

[Out-to-Lunch]

The entire purpose is to create another Tax Free account and pay minimum taxes in doing so.

The first deposit of let’s say $10,000 will be made with 22.2% withdrawals from our IRA account.

Hopefully, year 1 will result in a 10% LTCG which will be withdrawn and taxed at only 10.2%. The Tax Free (return of capital) size of the account is now $11,000. Year 2 we might add another $9,000 of 22.2% IRA capital for a total of $20,000. Then, if we can create 10% LTCGs we will again only pay 10.2% tax on those gains bringing us to $22,000.

We will be making smaller and smaller 22.2% IRA withdrawals each year while creating larger and larger 10.2% LTCGs as our Tax Free (return of capital) investments grow.

Maybe I am dense. I read this to say that you are planning to withdraw money from a tIRA, pay the tax due, and then put the funds into a taxable brokerage account. You then will gleefully withdraw the funds and pay only a small tax on the LTCG. What possible advantage does this have over instead making a Roth conversion with those funds? Then when you withdraw the funds, you will pay ZERO tax.

 

[Sandy & Shirley]

I personally look at this from a different perspective.

I am currently withdrawing $25,696 from my IRA each year to pay $7,696 in Fed, State, and Local taxes so that I can use the remaining $18,000 to make my $1,500 monthly mortgage payments. My total mortgage payments for 2023 will be $16, 800. My December payment will only be $300 to pay off my mortgage.

Plan A in 2024 could be to do a Roth Conversion where I withdraw $25,696 from my IRA and add $18,000 to my Roth, while paying $7,696 in taxes each year for the remainder of my life!

Plan B in 2024 would be to deposit $1,500 a month into a standard brokerage account and invest the money. Then, in 2025, at an average 12% return on my investments, my LTCGs would be $2,160 and my taxes on those gains would only be $388. My IRA withdraw in 2025 would be reduced by the LTCGs, so I could only withdraw $23,536 and pay $7,049 in taxes. My total tax savings in 2025 would only be $259, $528 in 2026, etc.

My estimated 2034 situation, at an average 12% market growth, would be a standard brokerage account with $212,085 of tax free investments, earning $25,450 in LTCGs, limiting my additional IRA withdraws to only $246 with an annual tax savings of $3,054.

If all my extra money was in a Roth, and I needed an extra $20,000 to buy a new car, I could make the Roth withdraw, but I couldn’t just put the money back whenever I wanted. If the extra money was taken from a standard brokerage account, also tax free, I could replace the money in that account any time I wanted to.


This is just a personal choice, and I do enjoy "playing the market".