Plan Ahead to Pay Less Capital Gains Tax

If you have a high income in retirement, it’s possible to pay 0% capital gains tax on your investments. With a little bit of planning, you can pay less in tax and also potentially pay less in health insurance costs If you’re retiring before age 65.

The difficulty with taxes sometimes is that a lot of people think, well, everybody’s gotta pay ’em.  But what many people don’t realize is that there is a lot of pages of the tax code that are there specifically to help you pay less tax. You don’t have to be a billionaire to get preferential tax treatment.

Here are three things to pay less estate tax – income planning, investment planning, and tax reduction strategies. 

The Income Sweet Spot

What’s the income sweet spot where you can get a 0% tax on long-term capital gains on your investments? And just remember, there are people living on $10 to $20K per month or more from their accounts each year in retirement and still able to use a strategy to get 0% tax on long-term capital gains. 

To do that, you need a taxable income of $41,675 if you are single, $83,350 if you’re married (these are the 2022 numbers). For example, let’s pretend that there was a couple getting an income from three sources in retirement. They just retired in their early 60s (or any time before required minimum distributions). They are getting an income from social security and from their savings. This is not from IRAs,  but from either bank or investments they have that are non-retirement. They get dividend interest of 10K per year that just come naturally from the investment account. So for this example, the only taxable income they have is from social security and then dividends, so $40K taxable income.

Depending on different income levels, Social Security is not 100% taxed. But for this case, we’re just pretending like that’s their taxable income. In this example, they might be able to sell investments that have a long-term capital gain of about 40K or so, and still pay a 0% tax rate. If they had higher income – if they were taking out of IRAs or  had higher social security they might be paying 7k to 10K in taxes. 

In this example, by thinking ahead of time about their income plan, they can save possibly 7k to 10K per year. 

When to Take Advantage of the Income Sweet Spot

One period of time that people can use this strategy is if they are unemployed for 1-3 years. Sometimes retirees plan working in the future, maybe part-time work or some sort of income in retirement, but they might take a few years off. This could be a period of time to look at this strategy, where taxable income is much lower. 

Another way that you might be able to take advantage of this is if you’re self-employed and you have a little bit more control over your income versus someone who is a W-2 employee.

But the most common time that we see people take advantage of this is retirees between age 60 and 72. After work is done and before they’re starting social security (sometime in the period  before starting required minimum distributions). 

Do I Have to Lower My Income?

If you’re thinking, “I don’t wanna really lower my income just to pay 0% capital gains tax. It doesn’t seem worth it.”  You don’t necessarily have to lower your income. Many retirees actually pay 0% capital gains and still get a large income from their savings and investments. You have to do a little planning the years before retirement.

Typically, retirees will build up their non-retirement funds, their non IRA pre-tax monies, or  non-Roth monies, in an account before they actually retire. In doing so, they’re building up a nest egg of money that doesn’t have to take a big tax hit when withdrawn.Whereas, if you’re using your pre-tax (IRA or 401k monies), every dollar that you take out is counted towards taxable income. 

So planning ahead and building this nest egg may have the least tax impact for withdrawals if used for the first few years of withdrawals. 

Avoid Estate Tax Through Charitable Giving

If you have investments that do have large capital gains in them, think about giving a portion or all of those investments that have the biggest gain straight to the charity versus selling the asset, and then giving to charity. 

One way to do that is with a donor advised fund. With a donor advises fund, you don’t  have to give everything to the charity in one year. You can spread it out over a few years and get the tax benefit this year. 

Mistakes of Implementing this Strategy

Now, let’s get into some of those traps that some people fall into if they’re thinking about this strategy or if they implement it. 

The first one is getting surprised in December by tax inefficient funds. Those tax inefficient funds are the ones that might recognize gains within the funds themselves. You may not even realize it, or you don’t have control over what the funds are doing. 

You may have seen this before on your tax return. You may have wondered, “Why are these big gains here? I didn’t take anything out, I didn’t use it, I didn’t sell anything. Why am I recognizing and having to pay tax on these gains?”  Many funds will do this and you really have no control over it. Two of the things you can control in investing are fees and taxes.

For example, this 0% capital gains tax plan is implemented, and gains are recognized, but they’re  doing it all and they’re under the 83K taxable income. Then they see in December, another 30K of capital gains gets recognized. What would happen is that this gain increases the taxable income, it increases the social security, and ultimately how much is taxable. It’s just a big surprise. 

Tax-efficient funds are really important in retirement. Those who don’t plan this way, it causes them to pay a lot more tax than they should. 

Avoid High Taxes on Social Security Income

If you’re thinking about the 0% capital gains tac, watch out for being in a period of low income. When you’re not recognizing these gains on purpose, your social security may not be taxed or it might be taxed at a lower rate.

Some retirees don’t realize this and their social security income gets taxed at a higher level and then increases their taxable income. 

Tax Reduction Strategies Play a Big Part in Retirement

As you already know, taxes play a big part in retirement planning. At Streamline Financial, when we’re evaluating the value we can provide for clients, we look at the investment alpha or return and the the tax alpha.This can really reduce how much tax you pay and can add to returns.

Remember, there’s a lot that goes into the 0% capital gains tax strategy. Make sure to talk to a financial professional before implementing these strategies just to make sure you’re not making any mistakes and you’re thinking through all the steps. Feel free to reach out to us!

Disclaimer: Since we don’t know your specific situation, none of this information should be construed as tax, legal, financial, insurance, financial advice, or other advice and may be outdated or inaccurate. It is your responsibility to verify all information yourself. This content is prepared for entertainment purposes only. If you need advice, please contact a qualified CPA, attorney, insurance agent, financial advisor, or the appropriate professional for the subject you would like help with. Streamline Financial Services, LLC or its members cannot be held liable for any use or misuse of this content.

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Disclosures: Securities offered through LaSalle St. Securities LLC (LSS), member FINRA/SIPC. Advisory services offered through LaSalle St. Investment Advisors LLC (LSIA), a Registered Investment Advisor. Streamline Financial Services is not affiliated with LSS or LSIA. LSS is affiliated with LSIA.