Some time ago I received an email from one of the big brokerage firms, titled “Savvy Year-End Tax Strategies.” It contained much advice on how to minimize taxes and how to reduce taxable income, such as “Consider contributing as much as you can to a 401(k)” and “Be careful when selling highly appreciated assets, such as stocks, land, fine art, precious metals, or antiques.”
This might be considered good advice by some, but I just call it, “Boring!”
Benjamin Franklin once wrote that nothing is certain except death and taxes. I beg to differ. I personally expect to never pay taxes again, legally and respectfully.
Perhaps you would like to do the same?
How to Pay Zero Taxes
There are many reasons to reduce or eliminate taxes. Some may have political, moral, or philosophical reasons for doing so. Maybe you don’t want to pay for wars, for example. But the reason that is strongest for me is also the most straight forward: If you are able to pay zero taxes, you don’t need to earn or save as much to live well.
[A brief aside: if you do have to pay some taxes, be sure to get a FREE vacation out of it!
Hint: try the generous welcome bonus on the card_name.]
Let’s use our example to make this clear.
Over the past 7 years, we have had taxable income of about $100,000/year and paid close to $0 in income taxes.
During that time, we have lived extremely well, spending an average of $75,000/year. But if we were chasing the normal American dream, working hard to advance our careers and grow our salaries, how much job-related income would we need to afford our same standard of living? $100,000? $125,000?
Try closer to $210,000, paying as much as $75,000 in taxes for the privilege (nearly our entire current cost of living!)
Paying zero taxes has its rewards.
So how do we eliminate taxes? All we need to do is follow 4 simple rules:
- Choose leisure over labor
- Live well for less
- Leverage Roth IRA Conversions
- Harvest Capital Losses AND Capital Gains
Choose Leisure Over Labor
The tax laws in the US target people who work for a living. If you get a paycheck, the US government classifies that paycheck as Earned Income, with special payroll taxes just for you. This is one part of the reason that Warren Buffett says his secretary pays more tax than he does. Social Security and Medicare taxes are only applied to Earned Income, 15.3% tax in total for most people.
The only way to avoid paying these taxes is to not work. Now leisure comes with an added bonus. I intend to never have earned income again, completely eliminating this tax.
Live Well For Less
The more a person or family spends a year, the more likely they will be required to pay income taxes due to the graduated tax brackets that exist in the US and many other countries. More spending = more income = more taxes.
Using the 2019 tax rules, a married couple can earn up to $24,400 a year without paying tax. This is because the government allows us a standard deduction of $24,400. Other deductions can be applied, such as for 401k contributions which reduce taxable income / increase the amount of tax-free income. (That advice from the big brokerage firm hit the spot on this one.)
Once income and spending exceed this level, taxes must be paid. Unless…
Unless that income comes from qualified dividends or long-term capital gains. In this case, a married couple can have $24,400 a year in income AND $78,750 in investment income, TAX-FREE (if that isn’t a strong signal to not work, I don’t know what is.)
(The standard deduction & income tax brackets and capital gains tax brackets are increased every year with inflation or some arbitrary level decided by Congress. Check links for the latest numbers.)
If income and spending are kept below these levels then we can avoid capital gains tax.
But wait, there’s more
Leverage Roth IRA Conversions – the Ultimate Early Retirement Tax Strategy
If we follow normal tax advice during our working days, we will retire early with a 401k or IRA or two. Except under special rules, this money can’t be spent until we turn 59.5, upon which it is taxed. But there is a way to avoid this, by converting it to a Roth IRA. Withdrawals from a Roth IRA are tax-free for life.
Once we’ve chosen leisure over labor, we can convert our 401ks and IRAs to a Roth IRA, a small amount each year. Any dollars converted to a Roth are considered income, but we can offset this with the $24,400 standard deduction. This is why we always contributed to Traditional IRAs while working, and never to a Roth (which seems to be a big controversy.)
Other income sources can contribute to this $24,400 limit, such as interest on bonds, rental income, short term capital gains, and earned income. Some deductions can also be made, such as capital losses and HSA contributions (a common option for people buying health insurance through the new government exchanges under the ACA.)
We reduce taxable income and pay zero taxes on the Traditional 401k / IRA contributions. We pay zero taxes on the Roth conversion. And we pay zero taxes on any growth within the Roth.
Harvest Capital Losses AND Capital Gains
Harvesting Capital Losses is a common practice. If you sold a stock for less than what you paid for it, you’ve had a capital loss. This loss can be used to offset capital gains and, if it is big enough, even up to $3,000 per year of Earned Income. There is a special rule for Wash Sales that needs to be watched out for – read our post on harvesting capital losses as a guide.
For stocks that have gone up in value, normally taxes must be paid on the gains. But… not if those gains and total taxable income are less than $78,750 (again, 2019 values, MFJ. – latest numbers here.)
In our own case, if we had investment income of $40,000 per year from Qualified Dividends and Long-term Capital Gains, then we have an extra $38,750 in tax-free capital gains to play with. Why not sell some extra stock, locking in that $38,750 gain, and immediately buy it back to raise our basis.
For example, let’s say we bought some of the VTI ETF over 1-year ago for $50,000, and it is now worth $88,750. It must be over 1 year ago in order to be considered a Long Term Capital Gain, an important time frame. Short Term Capital Gains are taxed at the normal marginal rate. Our basis in the stock is $50,000, with a $38,750 long term gain. When we sell it, we will pay NO TAX since we are keeping our total investment income below $78,750 (which also includes our qualified dividend income.) When we buy the VTI ETF back, our basis is now $88,750. The gain is locked in tax-free, forever.
For even more detail, I’ve written a Tax Gain Harvesting Template, with a step-by-step example of how we harvest capital gains. Enter your info here and I’ll email it to you.
Conclusions
Do you want to pay zero tax? Can you too Never Pay Taxes Again?
Following these 4 simple rules, it is possible for any US Resident to reduce taxable income and avoid paying taxes.
- Choose leisure over labor
- Live well for less
- Leverage Roth IRA Conversions
- Harvest Capital Losses AND Capital Gains
Maybe following these tax strategies will help you retire earlier and live better.
Never Pay Taxes Again!
—
A key part of our tax optimization is being able to quickly and efficiently view our full financial and tax picture. Empower is a great FREE online financial management tool. Give it a try
Update (1):
One item to be careful of is new with the Affordable Care Act. It is possible for an early retiree to get massive health insurance subsidies, as long as income is less than 400% of the Federal Poverty Level ($83,120 for a family of 3 in 2019 – latest numbers here.) At our $75k per year spending level, we qualify for several thousand dollars of assistance. Being aware of this threshold is important when deciding size of a Roth IRA Conversion or Capital Gain Harvest.
Read an in-depth review in our post on the Affordable Care Act and its tax implications.
Update (2):
It is one thing to understand the theory, and another to see it in practice. Check out our actual tax returns from 2013, 2014, 2015, 2016, 2017, & 2018. Or just view the summary, 6 Years of (Nearly) Income Tax Free Living.
Update (3):
If you have to pay some taxes, be sure to get a FREE vacation out of it! See how Uncle Sam paid for our trip to Hawaii.
A personal favorite for getting free vacations is the card_name.
Update (4):
Be sure to explore the other posts from the Never Pay Taxes Again series:
- Never Pay Taxes Again by Moving Abroad
- Never Pay Taxes Again with an Overseas Corp
- Never Pay Taxes Again Using Rental Properties
A special note:
Taxes are used for many useful and good purposes for the collective good, such as building roads, the filming of Sesame Street, and helping the disadvantaged. Isn’t it part of our moral obligation to help pay for these things?
I believe this is true, although it isn’t necessary to pay it annually. The taxes we paid during our working years were many, disproportionate to our use of roads (we bike and walk instead of drive) or our viewing of Sesame Street (we don’t own or watch TV.)
When it comes to helping others, there are many ways to help. The government helps in some ways, but other organizations do as well, more so even. Those organizations are very receptive to donations of both time and money. I encourage the giving of both.
As an added bonus, donations of cash or capital assets are tax-deductible :) And the donation of appreciated assets eliminates all capital gains taxes for both parties. Win-win. If this sounds intriguing, check out a post by JL Collins about making the most of your donations, How to Give Like a Billionaire.
Last updated: November 15, 2019
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Wow what a great post. I am not smart enough to critique it but you lay it out very clearly. My challenge is at age 57 I have some pretty ingrained spending habits and even though my wife and I are quite frugal we still manage to spend a ton of money. You young and super smart bloggers are an inspiration to learn from. Thank you for writing. I will read the links you provided.
Hi Mark
Thank you, I’m glad you enjoyed it, and thank you also for your kind words.
Best of luck on reducing your tax bill
Jeremy
I’m confused. What money would you have to live on in these scenarios? Your earned income allotment is being converted to a Roth IRA so you can spend that and the ETF you sold but then re purchased. The only money for living expenses in your s scenario is the $40k in dividends. But you say in the beginning you spend $75k a year. Please help me to understand. Thanks.
Correction: “covered to a Roth IRA so you CAN’T spend that”
A hypothetical, using Dividends, cash, stock sales, and side hustle income (if applicable):
Dividends – $40k
Cash – $10k
Food blog – $5k
Sell stock – $20k (realized capital gain <$5k - details)
If you wish, you can also spend Roth IRA contributions and any seasoned Roth conversions (aged 5+ years.)
I agree, great stuff. I hope to implement some of this and get out of the “I have to go to work” crowd soon. I want to do many things, but my day job is not necessarily one of them. Thank you for sharing this wonderful strategy!
Excellent post, Jeremy!
I’m actually publishing an article on tax-gain harvesting next week and will definitely be linking to this post in that article.
Only one more year of wage earning left for me and then I’ll be joining you in the $0 tax club!
I look forward to reading your article, Mad Fientist
One year will go by in a flash!
Ha, just got here from the tax-gain harvesting post Mad Fientist made linking to this article. :)
Welcome to the dark side :D
Hey Jeremy, I always enjoy reading your article about personal finance as I learn something new from you every time . Maybe it’s because of my accounting nerves, but I usually do some independent research and see if the same rule can apply to us. During the research, I noticed the 0% rate on capital gains will increase to 10% in 2013. How do you expect this to affect your tax planning this year?
Hi Chelsea,
As I read the American Taxpayer Relief Act of 2012 (signed Jan 2013), the capital gains taxes remain the same as they were in 2012. For earners taxed at the marginal rates of 10% or 15%, long term capital gains are taxed at 0%.
The table titled “Capital Gains Taxation in the United States” on this Wikipedia article states the same
http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States
This is now a permanent part of the US tax code, making permanent the so-called “Bush tax cuts.”
Cheers
Jeremy
The long term capital gains taxes remain the same, but what about the qualified dividends. Is it the same or did it go up as well?
They are both still 0%. See our 2014 tax return as an example.
I see nothing in this list where you are withdrawing from your Roth IRA without penalty. My issue is that I have a 401k and IRA with a decent amount that I can’t get out. I’d like to covert once I quit work or do a backdoor Roth. Is it best to bleed this amount off each year up to my 0% or low income bracket, then wait 5 years to withdraw penalty free? My assumption is that you didn’t write about taking money out of your Roth before 59 1/2 because you probably are not drawing from it. My income is way too high plus I have some rentals that make it impossible for me to convert without being in a high bracket. Just makes sense to do it when I quit work and in a much lower bracket. I hope to quit soon. I just turned 41.
Roth IRA is last on my list for withdrawals. Since gains are tax free, I want compound interest to work for as long as possible.
You may find answers in our posts on Cash flow Management or how we are building the world’s longest Roth IRA conversion ladder.
Brilliant post and great insights. One of the reasons yours is rapidly rising to the top of my favorite blog list.
Linking to one of my other favorite bloggers, MF, is a nice bonus!
Wow, thanks Jim! That is a real honor, and the feeling is mutual
I also really enjoy MadFientist.com. Every post makes me think. I’ve learned a lot there
I found the data on AICPA. If you search “Income tax planning strategies for 2012 – AICPA”, it will be the first one pop up in google. (I can’t copy the link as it’s a powerpoint).
Hi Chelsea,
I found that ppt. On Page 2, it states:
Bush tax cuts scheduled to expire at the end of 2012
He then goes on based on that assumption.
However, the Bush tax cuts were made a permanent part of the tax code by the American Taxpayer Relief Act of 2012 (signed Jan 2013), so his assumption that the qualified dividend tax rate increases to 10% in 2013 and beyond is incorrect
Another little thing to add to the final line of you post: if you donate appreciated securities, not only are they deductible, but neither entity has to pay capital gains taxes. I try to make all of my charitible donations through shares of appreciated stocks. You get all of the benefits of a donation, but the additional benefit of no capital gains taxes.
Excellent point to add, ptramma. Thank you, I’ve updated the post
Haha… I’m with Mark up there in that I’m not smart enough to critique either, BUT, I am glad you added a little ditty there at the end on your perspective of not paying taxes as moral obligation/etc. I actually had some drinks with Johnny Moneyseed the other night who linked to your post here and why I’m now reading (and, oddly enough, hung out with Mad Fientist too just last month – great guy!) and asked him that same question – about feelings of not paying taxes. I don’t remember what his answer was, but I told him I’m going to interview all extreme retirees and compile a list to blog about one day ;) If you’d like to be on it, I shall include you good sir.
Regardless, excellent post. First time here and liking what I see – thx for sharing!
Welcome J. Money, thank you very much for stopping by and for your kind words
I would be honored to make the cut for your list and future post. Thank you for the opportunity
Drinks are on me if you are ever in the area :) Budget friendly sexy ginger margaritas are just down the street
Rock on. Now if only I can catch up with y’all first wherever you are in the world! ;)
The year is now 2016 & the long awaited interview (via podcast) is now live! That’s what brought me to this article. I wanted to learn more about Cost Basis after hearing it on the M.O.N.E.Y. show. And I was certainly not disappointed. Thanks Go Curry Cracker and J. Money for all you do. Cheers to a wonderful rest of the year!
Interesting no one attacked you in the comments on not paying taxes. As if you have never paid taxes during your working career! Good summary of how to not pay taxes. That’s pretty much my plan, and having a few kids makes it even easier.
The ACA subsidies do make it a little trickier, and effectively impose an additional marginal tax at a relatively lower level than the top end of the 15% bracket (where you pay 0% on LT CG’s).
You could probably just pay the penalty and forgo US based insurance, now that you know you won’t be denied insurance later.
I was waiting for the attack comments. This post has been viewed thousands of times now and had some wide exposure. I guess it has to get posted on reddit before the haters come :)
I have a post coming on Obamacare, the tax implications, and our plans for health insurance. Stay tuned
Good luck. I’m going to write about how we will avoid paying $80k or so in student loans due to a low income and participating in the Income Based Repayment plan. Guaranteed way to get some negative comments.
I think you may have managed to ward off any negative comments with your addition at the end. A master stroke indeed ;)
All great advice especially about the tax advantages of charitable giving.
Justin, in this post you wrote “The ACA subsidies do make it a little trickier, and effectively impose an additional marginal tax at a relatively lower level than the top end of the 15% bracket (where you pay 0% on LT CG’s).” Can you elaborate on that a bit? I haven’t seen info about this elsewhere online. Tx, Tom
The ACA tax credit (commonly called the ACA subsidy) phases out as your income rises. It does this at a rate that’s roughly 15% effective marginal tax rate. In other words, if my income for a family of 5 goes from $40,000 to $41,000 I would lose about $150 in ACA tax credit. $150 higher taxes for $1,000 increase in income works out to 15% effective marginal rate even at a very low AGI.
I’ll leave this link here if Jeremy is okay with it: http://rootofgood.com/affordable-care-act-subsidy/
That’s my article on the ACA subsidy and shows how it changes as as your income goes up. GCC also has a good article on ACA subsidies too.
Good summary. Link away. Here are 2 more
https://gocurrycracker.com/obamacare-optimization-early-retirement/
https://gocurrycracker.com/obamacare-optimization-vs-tax-minimization/
Fantastic post! As someone who used to work in public accounting and the world of filing taxes, this makes total sense, and of course, appeals to many, myself included. You didn’t make the rules, paid more than your fair share while working, and shouldn’t experience negatively for taking advantage of the same rules that penalized you earlier. Charge on, richer, wiser, and tax-free.
Thank you kindly. Glad you enjoyed it!
Hello Jeremy – Thanks for the great post, I have enjoyed reading your blog and learning from you. Its exciting to witness people achieve financial independence and early retirement!
I wonder if you would mind a greenhorn follow-up tax question. You mention that one need not pay taxes on qualified dividends and/or long term capital gains if income from those and earned sources keep you within the 10%-15% tax bracket threshold. In 2012, as you have mentioned, this amounts to $70,700 for qualified dividends/long-term cap. gains.
Lets say that one actually had an income of $70,710, ten extra dollars from qualified dividends/long term capital gains, which places them in the next marginal tax bracket (25%). May I assume that only those $10 extra dollars would be taxed at the next marginal tax rate? Or would the additional $10 disqualify the first $70,700 from being tax-free?
I think I know the answer, but I want to get your feedback. Thank you for your thoughts.
“May I assume that only those $10 extra dollars would be taxed at the next marginal tax rate? Or would the additional $10 disqualify the first $70,700 from being tax-free?”
It’s the former. You would pay tax on the $10 extra dollars at a rate of 15% (the div/cap gain rate for the ordinary income 25% tax bracket).
Hi takalak
Thank you, I am grateful to hear that you are enjoying the blog
The answer to your question depends on where your income comes from.
If the income in question is from Qualified Dividends and Long Term Capital Gains only, then the extra $10 would be taxed at 15% (the max tax rate for dividends and long term gains.)
If the income is from “other income”, (interest, short term cap gains, earned income from a job, IRA distributions due to ROTH conversions, business income, etc…) it would be taxed at the marginal rate of 25%.
In other words, if we overestimate how much of a ROTH conversion to do we don’t get stuck with paying a huge tax bill, just a few dollars for however much we overestimated
It is important to note here that an extra $10 of “other income” only counts if you have a total “other income” that by itself puts you in the 25% marginal rate, which would be $37,850 in 2013 (for married filing jointly)
You can experiment with different values using a spreadsheet and the Qualified Dividends and Capital Gain Tax Worksheet for Line 44 of the 1040, or you can use Intuit’s TaxCaster tool (easier but with less visibility into the details)
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
Thanks, Jeremy (and Justin) for answering my question! I am glad to know that the first ~$70k of long-term capital gains / qualified dividends are tax-free. It feels good to know that my earmarked (and predicted) early retirement distributions in those categories will not be taxed. I was able to confirm this by plugging this scenario into the tax calculator as well, great resource by the way! Thanks again :)
Anytime, glad I could help out
And thanks Justin for a much shorter/better answer :-D
Glad to help out. I get the “but you’ll have to pay so much in tax when you retire!” comments a lot. Which isn’t generally true if you’re spending is only $30-40k or so (for a married couple).
Hey Go Curry Cracker!, I know it’s almost 10 years later, but I stumbled upon this post and have found it very informative.
In the above comment of yours, can you explain how the extra $10 of “other income” only counts if your “other income” is $37,850?
It counts. The tax rate you pay depends on total income. If still in the 0% tax rate region then no additional tax.
Where are all these qualified dividends coming from? In the Mad FIentist podcast which pointed me to your site, you said you were heavy in VTI… which I also own… which a quick double check tells me that it throws off ordinary dividends. In fact, I was disappointed to see all the index funds I have like IVV, VTI, and VNQ are ordinary dividends.
I’m about 28 with a 60+% savings rate and 1 year/20% into the FI journey, so I found your story of actually doing this very inspirational.
Hi Reepekg
Welcome, thank you for stopping by and for the great question
A lot of what VNQ pays out will NOT be a qualified dividend, as it is a REIT. That is just the nature of the beast on this one. REITs are best held in a tax deferred account for this reason
For VTI, the majority (if not all) of the payout will be qualified dividends if the fund is held longer than 60 days. But, if I look in my brokerage account right now they show 100% of payout to date being ordinary dividends, with this disclaimer:
“The tax information reported above may not reflect all adjustments necessary for tax reporting purposes and may not be appropriate for use in preparing a tax return. Qualified dividend and post-May 5 capital gain income that may be taxable at the reduced rates introduced by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JAGTRRA) may not yet be separately reported above.”
That is a long way of saying, “Don’t worry about it, when we send you your 1099 in early 2014 it will all be OK.” On my 1099 from last year, 100% of the VTI payout was reported as qualified dividends
A 60% savings rate at age 28 is impressive! Well done, and congratulations
Cheers
Jeremy
I wouldn’t worry about VTI and IVV. They should spit out almost 100% qualified dividends. VNQ and similar REITs won’t be all qualified, but some of the “dividend” will be return of capital (ie not taxable income at all). For VNQ I seem to recall about 1/3 the dividend was non-taxable return of capital.
The biggest funds I own that don’t pay nearly 100% qual. divs are the international funds. A portion of the dividends are qualified, but half or more might be non-qualified (and get taxed as ordinary income).
The international funds (often) will have tax withheld before the dividends are paid to you. That international fund owns some stock of French companies? Some tax gets paid to France. Some stocks in Japan? Tax gets paid to Japan
Since the US government gives US citizens a credit for foreign tax paid on their tax return, it can be a good strategy to have some US tax liability
For example: We own some VEU. Last year we paid about $400 in foreign tax on the distributions from this fund. Even though we intend to pay $0 in US tax this year, I am planning to “owe” $400 of tax which will then be wiped out by the foreign tax credit
Good point. We had $320 in foreign tax credit last year, primarily from VEU and VWO. Nice to get credited back for taxes you pay to foreign companies!
Ah OK, thanks for clarifying this point. I just checked the one line statement in my brokerage account from the date the dividend got paid out which lists it as either “qualified” or “ordinary.”
Since this is the first year I’ve saved enough income to invest in a taxable brokerage account, I’ll look forward to that 2014 1099.
It’s good to pay attention to tax treatment of dividends for taxable investments. At vanguard (and presumably most mutual fund/ETF sponsors), they have info on previous years’ qualified dividends. Check it out here:
https://personal.vanguard.com/us/insights/taxcenter/qdi/yearend-qualified-dividend-income-2012
Looking at that list, my international real estate fund at vanguard is probably the worst offender for qualified dividends, with only 11% qualified (the other 89% = ordinary income). It might pay to stick a fund like that in an IRA. Although you lose the foreign tax credit eligibility in an IRA.
Can you tell me if by “no taxes” you mean no income taxes? Or do you mean no income or FICA? I’ve googled and googled and can’t find anything to suggest at what point you start paying FICA. I’ve been assuming you start paying FICA at dollar one. Thanks for the help!
Hi Laura
You pay FICA at dollar 1 of earned income. Social Security and Medicare taxes are only on money you make from a job, and are not applied to dividends, capital gains, etc
Since we are funemployed, we pay no FICA or income taxes of any kind
If you have a job, there is no way to eliminate all taxes
Hope this helps
Jeremy
This is an awesome, awesome post! Thanks so much for easily clarifying this. Listened to the podcast with you & MadFientist last week. Love the idea of continually upping your cost basis under the allowable threshold to avoid paying tax on capital gains. I never thought of that and was trying to figure out how to account for the income from our taxable investment account in FI. Thanks for putting this together.
Thank you Elizabeth. It is comments like this that inspire me to keep writing
Hi. I found your blog from lifehacker and am loving it! I am 34 years old, work for the state of Illinois, and just became debt free. I have an extra $5,000 each month to invest. I know nothing about investing or making taxes work for me. I can tell this article was well written but starting with zero knowledge it is over my head. Is there a book you could recommend? Maybe another article you have written? Should I go to a financial advisor? Any help you can give me would be greatly appreciated! Thank you.
Hi Abby, welcome. Congratulations, debt free and $5k a month to invest at age 34 is a great place to be. The advice MarkT gave is spot on. Be sure to read through Jim Collins’ stock series and understand what you are getting in to, and then open a Vanguard account and get started
All the best
Jeremy
Abby – Simple answer, Vanguard.com and find a low fee index fund. More in depth answer, read jlcollinsnh posts on this http://jlcollinsnh.com/stock-series/
Great answer, thanks Mark
Hi Jeremy, I just started reading your blog. Great articles and analyses. I am an accounting professional and live in San Jose, CA. I can totally relate to your blog. Do you mind explaining how you arrived at the amount of $70,700 tax free investment income? Also wouldn’t the investment income be subject to long term capital gain tax of 15%? Thanks very much for your time!
I had the same questions.
The $70,700 number comes from the Qualified Dividends and Capital Gains Tax Worksheet of the 2012 IRA 1040 form for a married couple filing jointly.
The tax rate for Long Term Capital Gains and Qualified Dividends is based on your marginal rate. If your marginal rate is 25% or higher, then that rate is 15%. If your marginal rate is 10% or 15%, then it is ZERO.
To help make this more clear, you can try the TurboTax TaxCaster
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
Try entering different values of income from qualified dividends and long term gains and see at what levels you would need to start paying tax
Thanks so much for the pointer ! great stuff !
This blows my mind. I am not financially ready yet to take advantage of these tips, but I am very grateful to know what to study up on when I get there. Thanks, super cool post!
One thing you can take away now is to take advantage of your tax-deferred accounts to minimize current taxes.
I think your article would of been more complete had you mentioned the fact that you live in Washington where there is no State income tax at all. Most states (43 of them) levy tax on dividends and capital gains at the normal rate income tax rate of 6-10%.
You are probably right. Being 100% complete might require a 200 page book though
Technically I’m a resident of Washington State, but I haven’t been there in over a year. I’m not sure if that means I can say I live there
One great thing about Washington and other states that have no income tax, is that residence isn’t an exclusive club. Anybody can join
Thanks Ricky
Love the blog! I was wondering if you have a good resource (book or online) to really dive deep and learn capital gains/loss harvesting. Thanks!
OK, so I’ve used these methods and shared them with others, especially students,
who have used them to avoid taxes and loans. If Grandma gave you stock for school
and you harvest the gains with little earned income, you are using what I call the
“Poor Little Rich Kid” tax dodge. I’m sure every congressman’s kids use capital gains
to pay for school and don’t pay tax on the first $45K ($70K for a couple). But, now, say
you have stocks and are self-employed. You open a 401(k) (self-employed) account
and you use proceeds from sale of the stocks to live on and you plow as much of your
earnings as possible into the 401(k), thereby deferring most of your income tax and paying
no tax on the capital gains. Of course, you do pay FICA, but you want to do that to insure
you get the best annuity one can buy, Social Security, when you retire. So, you pay little or
no tax now, while working, but, if you retire early and live on the 401(k), you pay 10-15%
tax on those funds. Have you shot yourself in the foot by moving out of capital gains and
into the 401(k), remembering that you paid no tax while converting taxed stocks to tax-
deferred accounts? I could go through the numbers in Turbo-tax, but its easier if someone
already thought through this.
Hi Warren
I’m not sure I follow everything, but 3 things stand out
1) A 401k is a powerful tool, and the self-employed version even more so. One needs to be careful not to save too much in a 401k / Traditional IRA though, less one get stuck with big RMD tax bills later
http://jlcollinsnh.com/2014/07/27/stocks-part-xxiv-rmds-the-ugly-surprise-at-the-end-of-the-tax-deferred-rainbow/
2) Social Security isn’t that great of an annuity. The overall ROI is pretty horrible in fact
https://gocurrycracker.com/social-security-and-early-retirement/
If we were to buy an equivalent annuity in the open market, the costs would be substantially lower than what we effectively pay through the SS system
3) Those nice civil servants in DC make a pretty good income, so are probably not able to pay zero tax on capital gains. Still, it is good work if you can get it
Cheers
Jeremy
On your third comment, yes, the servants make money, but their
kids in college don’t, so the servants build an account in the kids’
names and the kids live well tax-free for their college careers. Remember Anne Romney saying things were so bad, they had to
sell stock to make ends meet when Mitt was in college? What a
joke. What I am saying is that the rules are unfair for a reason
and guess who writes them.
You’ve avoided this so far, but I think I’m going to make the ‘attack post’ you’ve been waiting for, but I’m going to try to be respectful.
First, you claim that your usage of public resources and services is disproportionate to your usage of them. How do you calculate this? I do not believe it is possible to do so. So you walk and bike a lot, great. It’s a great health benefit and has no gas costs. Lots of people in large cities do the same thing (mostly out of necessity, but the difference is unimportant) and they still pay taxes that support roads. Are they the average taxpayer in terms of road usage? I have no idea. Maybe.
Second, let’s pretend you do know that your usage is lower (far lower) than average. If all of those people (including yourself) never paid any taxes toward roads, would roads still be financially viable or sustainable? I’m not saying the answer is no, but it IS a possibility. I am in fact under the (admittedly non-evidence-based) impression that public services like roads can only exist because the vast majority pay taxes to support them. If the number of FI’ers grew large enough to invalidate that assumption, your roads would eventually fill with potholes and the car you drive (I assume later in life you will need a car due to aging) will suffer more maintenance costs and you’ll directly feel the impact in both your driving comfort and your dwindling wallet.
Third, what data do you have to support the claim that “other organizations [help] as well, more so even”? Trying to qualify a single organization’s public benefit is a crapshoot, even with statistics from sites like Charity Navigator. Sure, you know how much of your donated money is going toward the cause, but that isn’t the same as knowing how much good they’re doing. How do you compare the public good of supporting the installation of a well in Kenya to handing out coats to the homeless in Wisconsin? You can’t. Trying to qualify a larger number of charitable organizations is only going to be harder.
By the way, today is my first time reading your blog. I found my way here from MMM and then jlcollins. It seems to be a nice one; you’re obviously a smart person and have done well for yourself. Thanks for writing it.
Hi Chris
Thanks for stopping by and kicking the tires. Great questions! (and very respectful too, thank you)
I haven’t calculated any of these things, but your questions made me curious so I did a little thinking
re: charities. Yes, hard to compare impact of public good vs. dollar spent, and I won’t. Certainly this challenge applies to both government and charities. Some of it is subjective… would you feel better spending $1 on coats or wells? Some of it is objective… what percentage of total funds received is used for direct benefit of the intended recipients?
The quagmire gets deeper when we start to consider that in many cases government and charity organizations work together.
In the end though, my statement was largely based on the fact that charities do things that government will not. For example, the Bill and Melinda Gates Foundation focus on family planning in developing countries. Avoid the politics and just focus on the goal is an advantage NGOs have and use
re: roads. Contrary to your assumption, our intent is to never own a vehicle. Old and decrepit? We will live much as we did in the prime of our working years, in a walkable community. In addition to being a great way to live, it will also avoid harm to others that we may cause while driving as our eye sight, reaction time, and awareness decline
https://gocurrycracker.com/home-sweet-home/
Our personal impact on the roadways can be measured, and includes both direct and indirect impact. Direct impact from use of roads, and indirect impact from use of roads by goods and services that we use.
If we drive a car 100 miles per year, ride a bicycle 1000 miles per year, and primarily purchase local produce at farmers markets, I think we could agree that our impact is less than average.
One of my favorite posts on this topic does a great job of estimating road impact of biking vs driving vs large transport vehicles http://www.cyclelicio.us/2014/fourth-power-rule-road-tax/
In short: If road damage from riding 1 mile on a bicycle is 1, then the road damage from driving a Prius 1 mile is 38000. I can ride a lifetime on a bike and do less damage than 1 mile of driving a Prius (The impact of an 18-wheeler is 252,000, ~6000x that of the Prius.)
It would be great if each vehicle paid a use fee based on its true cost. They don’t. But when we do drive (100 miles per year) we pay tax on the fuel we use. When we take taxis, we indirectly pay the same
Now the federal tax on gasoline is 18.4 cents per gallon and the average fuel economy of the car fleet in the US is 21.4 mpg. http://www.artba.org/about/transportation-faqs/#5
This translates to less than $0.01 per mile. I’ve already paid a lifetime worth of user fees for myself and thousands of others. Keep the change
As for “what if everybody did it”, these thought exercises are seldom useful. But let me ask this: What would be a better world, a world where a large number of people sought FI and rode bikes, or the world of today where many people work to consume and drive? Let’s build a world where fewer roads are necessary because people walk, bike, and take public transit, where city centers are built around people and not cars. Amen
Thanks Chris. Hopefully you will find our little blog of interest and share more of your thoughts and questions. Cheers to MMM and Jim Collins for making the world a better place
Jeremy
Hi Jeremy,
I enjoyed reading your tax post and some of these discussions. I am a bit puzzled about the road damage estimates in your post. If the road damage factor of a 18-wheeler is 252,000 and of a Prius is 38,000, how can that be a 6000x factor? Did you happen to miss some 0s for the 18-wheeler?
Thanks for your interesting and detailed early retirement posting. Willing to live a very simple life is a remarkable character. Best wishes to you and your family.
Chih-Lin
There are 3 missing zeros. Data comes from the Cyclelicious link
I found your blog a few months ago, and I stumbled on this today. Forgive me, but you strike me as being incredibly narcissistic and myopic on this. You are focusing on the costs of roads and ignoring so very much. Taxes pay for so many things. Like fire services. Or police services. Or the courts. Or funding for technology I am positive you use (internet, GPS, cellular radio, to name just a few). Social safety programs that you might need one day. Education. Military protection. Environmental protection programs. Roads that efficiently ship the goods you use (even though you may not use them directly yourself). And so on. No man is an island!
You are wanting to have your cake and eat it too. Enjoy the fruits of civilization without sharing in the costs of them.
You are probably right.
What would you advise I do?
I would argue that folks who minimize taxes can only do so by paying a lot of taxes during their accumulation years. It’s almost like you have front loaded taxes to the earlier part of your life. Often times decreased spending on homes and other tax deductible items may lead one to spend more on taxes in the early years. Also, I believe that the tax system is set up this way so that taxes aren’t a large burden to retirees, regardless of their age.
I hate to dredge up old comments on an old thread, but I have just recently stumbled upon your blog and felt inclined to leave a comment.
Coming from someone who is active in local politics, I can assure the readers, at least in my area, a resident of Texas (another state with no state income tax), items like Fire Service, Police Service, court systems (which charge users “court costs” every time someone uses the system, hardly a tax funded system), education, and environmental protection programs are all funded through local sales/use and ad-valorem/property taxes. Even the federal contributions to these systems could be minimized if we kept our national taxing low and focused on budgeting/taxing/spending locally and state based, where our representatives are more accountable than at the federal level (i.e. If the federal government wasn’t wasting money on a Department of Education, there would be more money for local taxing authorities, the the state or county for instance, to tax. The overall amount of tax paid wouldn’t change, but why pay the federal government to pay a bureaucrat to give grants to local jurisdictions when the local jurisdiction could just receive that directly?).
As for the rest of the listed items that are specifically done only on a federal level, like military protection and social safety programs, I agree that these items need to be paid for but why should it be the authors responsibility? If we follow the doctrine of Corporate Personhood, corporations pay income taxes and pass this cost on to their consumer, so as the consumer is spending money aren’t they also indirectly paying those taxes already when following the system outlined in the original article? Not that all consumerism is corporate-driven, but corporations are a very large cog in the machine.
Thanks for your time and I look forward to bookmarking this blog to continue educating myself in this subject.
This was a very informative post. I’m afraid I don’t have quite what it takes to navigate taxes and all that yet though. I’m just starting to tinker with mutual funds and all that fun stuff. I hope to be financially independent by 40, which is fifteen years from now. I notice this depends on being married though. As a mgtow I have every intention to avoid marriage as best I can, though I’m not opposed to a religious/nongovernment wedding. How does this work as a single male? It seems we’re targeted particularly viciously by the taxes, especially after aca which seems to intentionally go after single men. Is it even possible?
Hi C
There is no dependence on marriage. You can divide all of the numbers above by 2 and arrive at the equivalent tax levels for a single person. And as a single person you could spend half as much (or depending on who you ask, less than half.) Seems pretty equal
I suppose everybody thinks the ACA is unfair to someone. People without kids think it is unfair they “have to pay for people with kids.” The wealthy think it unfair they “have to pay for the poor.” The people without pre-existing conditions think it unfair “they have to pay for the sick.”
For a single male, most of what I’ve read suggests women pay more for health care benefits than men, and more for services. In any case, I don’t find that way of thinking to have any benefit
At the end of the day, health insurance is not that expensive. As a percentage of budget for somebody that can save enough to retire in 15 years in particular. I’d just pay the bill, enjoy the health coverage, and move forward with my saving and investing plan. That other stuff is outside your sphere of control
Good luck!
Jeremy
Thanks for the extremely informative post. I do have to disagree about ACA. I’ve seen my premiums rise from 1400 a year to over 4000/year for a worse high deductible/HSA plan. To get an equivalent plan to what I had 5 years ago, I would have paid 600+/month for this year’s insurance. I have to go through the exchanges since I am a contract employee (not complaining, as I am well compensated for that fact. Just illustrating)
We agree, so no need to disagree. If you earn more than 4X the FPL (so no subsidies) your insurance will cost more than a high deductible plan of yesteryear.
Thanks for this story. I find this strategy really fascinating, and would love to be in a position where we could implement it say 10 years prior to drawing money from retirement accounts. But I have questions about what happens, in theory, after one reaches the age where one starts collecting social security. How would drawing social security impact your future tax implications after you’d implemented this strategy? To throw out some theoretical numbers, let’s say at age 62 a husband and wife start taking:
10,000 a year in long term investment gains from non-retirement accounts
16,000 a year in long term investment gains from Roth IRA accounts
12,000 a year in long term investment gains from 401K or regular IRA accounts
20,000 a year from Social Security
What would be taxed at that point? How might you prepare to minimize taxes once you start collecting social security?
Hi Wendella
This is a fairly complex situation, and as such hard to answer in a comment.
I’ve touched on this subject here and here
You can get a rough idea of tax load by looking at the graphs in this post
But in general, your Roth withdrawals are tax free, income for MFJ is below ~$90k so dividends and cap gains from the non-retirement accounts are tax free. The 401k withdrawal will be taxed as regular income, and the SS will be mostly untaxed as well since total income is below the SS taxation threshold of $32k (for 2014) (tax formula uses 50% of SS for threshold test)
I have a post in the pipeline about Social Security that will go a little deeper. I’ll also do a Reader Financial Review where SS plays a role when I have a good candidate
In the mean time, hopefully this helps
Cheers
Jeremy
Thanks so much for the reply. That’s very clear, and again, thanks for posting about the strategy. The cynic in me assumes the tax law will change before I’m in a position to implement this, but I’ll keep my fingers crossed! :)
Jeremy,
Great blog. The stuff you and Mad Fientist are writing about is blowing my mind. I know for 2015 for MJF income is $20,400, correct? But, where are you finding the amount of long term capital gains and dividends that are tax free? For 2012 you said $70,700. Where are you getting that number from?
Thanks Joshua
That number comes from either the Schedule D Qualified Dividends and Capital Gains worksheet, or you can pull it from the tax tables as the upper edge of the 15% tax bracket
I am able to max out my 401k and plan to do the SEPP withdraw method, as I won’t have enough after tax savings to live on while I convert to a Roth. This method works great if you have 200+ in after tax accounts, but that won’t be me.
My plan is to have about 550k in 401k by 46, sepp payments will be about 19k until 59.5, also I hope to have around 130k in roth that I will use for the 13 years until I turn 59.5.
If the calculator I used is correct, using sepp, assuming I still get ~7% my balance will actually grow to around 900k by 59.5, so I’ll be in better shape then. :)
Thanks for the nice article. What about someone who makes $300,000 a year?
At that level of income, tax will be due
How do you expect to never have earned income again if you generate revenue from this blog?
Last year the blog made about $2,000 (maybe $5/hour?), and I had to pay some self-employment tax on that income. Income tax was still $0. See my 2014 tax return for details
That’s what happens when you violate Rule #1
Excellent article and congrats on the early exit from the work world. My wife and I did the same thing in our early 40’s and I was beginning to think we were the only pink elephants out there that think like you in regards to finances. ;) The freedom is priceless and 5 years on, it’s by far the best decision we’ve made in our life.
Question: While I hear you on the income end of things, I’m guessing based on your $2000 income that you got the benefit of the EIC as a result?
Awesome, congratulations Steve. It is hard being a pink elephant in a workaholic world
We don’t benefit from the EIC because investment income is too high. But we will receive the Child Tax Credit
So if I expect to have $65k a year income from a pension, then when I add in my SS benefits and tax deferred withdrawals, which puts me up over $120K/yr, I will always be paying taxes at the nominal 25% then, correct?
With relatively high pension and SS income, you will always pay tax. Each dollar out of the tax deferred accounts will be taxed at the marginal rate
Help, I’m confused. The way I read the blog it’s saying that the first $19,000 you make is tax free. I’m assuming this is referring to capital gains, since the first tax bracket for earned income is 10%, not 0. Also, distributions from an IRA in retirement count as income and therefore are subject to income tax, they don’t count as LT CG. Please point out what I’m missing. I’m trying to figure out whether to invest in an IRA or Roth IRA. Last year’s gross income was 54k, but thanks to interest deductions, actual tax rate was more like 8%. Any advice? I probably won’t be in the next tax bracket for quite a while, sadly
Hi Nathan
This stuff is a little complicated when you first start looking at it
The main thing you are missing is the Standard Deduction and Personal Exemption. The first dollars from any source are taxed at 0% due to these deductions
See this post for discussion of IRA choices:
https://gocurrycracker.com/turbocharge-savings/
Thank you very much for sharing all of this information. I am a college teacher and have a question for you. Earlier, you mentioned selling your house. Why didn’t you considering keeping it to sell it at high point (meaning, keeping your house as an investment)? Also, didn’t you find it advantageous to keep the house and be able to deduct the interests? I wonder what you thoughts are about renting vs. buying a house for someone who is in the middle low income bracket. Thanks for any insights and I am looking forward to reading your response!
Hi Selena.
This post represents my thoughts in general on single family housing: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/
Based on current interest rates, the mortgage interest tax deduction really only benefits those buying expensive homes. Middle low income homes will fare better with the standard deduction
Hello Jeremy,
Thank you for your time and attention in responding to my question. The article has many valid and interesting points, and I will need some time to digest them (and take action!).
Congratulations on this great blog!
Thanks Selena. As you digest, if any questions come up just ask. Happy to help
I started working last year, I live in Puerto Rico and I’m an Occupational Therapist. I don’t receive any retirement benefits because I work by professional services and I want to start making smart decisions from the beginning. The problem is, I don’t understand half of the terminology about finances and don’t know how to start. What articles or books do you recommend for a complete beginner?
I have a list of recommended books. Get them from the library if you can
Also Jim Collins stock series
http://jlcollinsnh.com/stock-series/
Thank you!
You mention you’re a WA state resident, but you’re living in Taiwan. Do you own property in WA? Rent a place?
More to the point… If I plan on living an itinerant lifestyle such as yours, what’s the cheapest way to establish residency in a low-cost state?
Hi Drew
Move to a no-tax State, get a drivers license and register to vote, open a bank account, live there for 6 months or whatever their legal requirement is. Cut all ties to other States, no bank accounts, no property
Your legal residence is now in a no-tax State and you are free to move about the world
There may be easier ways, but I haven’t researched it in depth
Good luck
Jeremy
How do you maintain residency once you have it and what address do you use (not asking for your actual address!)? We love the idea of not having a place to pay rent on or to own, but when thinking about filing taxes and utilizing the WA exchange for healthcare, we are continually at a loss for how to manage this without having an actual residence anywhere. What do you do for this? Thanks.
Often legal residence remains in place until you establish a new residence somewhere. Examples exist where aggressive states like CA and NY have tried (successfully?) to tax former residents who have moved on, on the premise they didn’t establish a new residence elsewhere.
We use a friend’s house in Seattle as our address. He processes our (very limited) mail, but we will probably transition to Traveling Mailbox this year.
For using the WA exchange, I don’t think this has much value unless you are actually in WA. All policies we have seen have limited coverage outside WA (or outside network even.)
Excellent! Thanks. I’ll check out your articles on ACA. Figuring out healthcare for our little family is the next big piece of the puzzle as we set off traveling again for an indefinite amount of time. Cheers.
For a head of household the numbers are the same?
Single= head of household?
Head of household is different than single, with a larger standard deduction and wider tax brackets. Numbers here.
Forgive me if I’m kind of confused by this post.
You say to choose leisure over labor, i.e., do not “work” and live off investment capital gains and dividends. Is this post about a retirement strategy or something you can do right now? I don’t see how I can fund the investments AND live off the gains (which are not guaranteed).
If I missed something, could you clarify what step 0 would be? Thanks!
If you work, you pay tax. There is no way around that
Step 0 – eliminate debt
Step 1 – accumulate capital
Step 2 – follow the plan outlined in this post
What about traditional IRA contributions… It’s not 2012 anymore, but no matter… Based on your 2012 suggestions of $19,500 in income, and $70,700 in cap gains/divs… shouldn’t we add another $5,500 in income that you can contribute to a traditional IRA that’s offset on line 32? Take that number from $19,500 to ~$25,000 in income…
By following Rule #1 – Choose Leisure over labor, there would be no earned income to contribute to a Traditional IRA. If there was some small amount, with an effective marginal rate of ~0% a Roth IRA would be a better choice
This post touches on this for the Accumulation phase
https://gocurrycracker.com/turbocharge-savings/
Great site.
Have you heard or considered combining tax free investment income with tax free gains on primary residence sales? I am a builder and am consider shifting part of my home equity and portfolio to buying property, making improvements and selling every two years to maximize tax free return.
Just a thought…
Since you have some expertise in this area, maybe you can make this work. The tax free gain on your primary residence is a nice bonus,
Rereading of few of your articles to try to learn this stuff, followed your suggested link to Mad Fientist’s article, and then his link to Taxcaster to play with some scenarios. True enough, with 100% income from capital gains under a certain amount I pay no tax. BUT, as I added wage income at first my tax stayed at zero, then I started getting a refund which peaked at $2000 for wage earnings something above $30,000. The refund was from the tax credit you get if you have two kids under 16 and earn less than a certain amount, but this credit apparently is only triggered if you have some income from working. No credit for solely capital gains income. So….am I really better off tax-wise to work some to trigger that credit or am I missing something here?
There are (at least) two credits that can be claimed for families with children, the Child Tax Credit (CTC) and the Earned Income Tax Credit (EITC)
The CTC can be claimed as long as you have tax due, which we will ensure via larger Roth IRA conversions. The EITC is aptly named, as it only applies if you have earned income. Any investment income quickly makes you ineligible for the EITC though, so there is a balance. I haven’t studied this in depth, because our dividend income disqualifies us
There are some advantages to having a small amount of earned income. FICA tax will be due on all of it, but income tax could still be at 0% and each person is eligible to contribute up to $5500 to a Roth IRA in 2014. I did this in 2014 with the <$2k in blog incomeThere is some discussion of the CTC and EITC in the comments section of this post: https://gocurrycracker.com/go-curry-cracker-2014-taxes/
very interesting post – it wasn’t exactly clear how this worked, and being a CPA, I had to be a little skeptical. However, I researched this and was not aware of the phase in on the taxation of qualified dividend income. So if I understand this correctly, you can have earned income up to the amount of your Standard Deduction and Personal exemption, which then wipes out the taxes on the ordinary income. The phase in on the qualified dividend income allows you to collect a healthy income of dividends – for 2015 $74,900, without paying taxes!! This is probably what I clear AFTER paying taxes – with much more effort! Now the kicker – you probably need around $1.5M in dividend paying stocks (yielding around 3.5%) to provide 50k +/- in qualified dividends. (still something to shoot for)
Just found this website today. Where would I find out what the phase in of qualified dividend amount would be for 2015 for a single person? I would like to read up on this as I am a tad confused. Thanks so much.
Hi Patty. You can look at the income limit for the 15% marginal rate on the IRS website or the summary as shown in this Forbes article
http://www.forbes.com/sites/kellyphillipserb/2014/10/30/irs-announces-2015-tax-brackets-standard-deduction-amounts-and-more/
Found this link from MMM and am hoping to follow some of these pointers, however I had a few questions. Do the new tax rules sort of put this plan on the rocks? Per 2015 laws $19.5k falls in the 15% bracket so that transfer would be taxed. I guess you could transfer less and fall into the 10% bracket but it doesn’t look like there is a 0% option anymore. Also, wouldn’t you take a penalty for early withdrawal from the Roth? Thanks for the great article. I still think the advice holds pretty true, just maybe the numbers have changed.
Hi Reese
There is always a 0% option due to the Standard Deduction and Personal Exemptions. All of these methods work today perfectly well
There is no early withdrawal from an IRA. There is a Conversion, which has no penalty
The numbers have changed, but only for inflation. Everything is functionally the same
Ok, do I have this right? The conversion is where you move the $$$ from the traditional to the roth paying “income” taxes for the move. Tax rate is dependent on how much you move. Idea would be to move only what is needed so that your “income” stays in the lowest bracket possible. Once the money is in the roth with taxes paid, whatever they may be, now it can be withdrawn for use.
Yes, although there is a 5 year waiting period for accessing the conversion funds. Access to any earnings is still restricted until Age 59.5
I read your “Traditional vs Roth” post with a lot of interest. I’m really appreciating the way you think!
This post is no different and I want to make sure I understand. I’m a sole-proprietor and am able to have a Solo 401k that I can contribute over 30,000 per year to. However, I plan on having a retirement income of less than 50,000 (tax adjusted of course). Rather than put all 30,000 in a tax deferred account, would it make sense to put 15,000 in the deferred 401k (to create the first 20,000 or so in income which would be 0% interest because of deductions for spouse and self) and the remaining 15,000 in an account that would generate capital gains (that would then be in the zero tax bracket), thus giving me zero taxes to be paid at that point?
I understand I’d have to pay current taxes on the capital gains account but my bracket is only 15 at this point so it seems to make sense to pay 15% on half now, only 2250, then be tax free 20 years from now.
Or have I over thought this whole process?
You may do better putting everything in the Solo 401k
https://gocurrycracker.com/turbocharge-savings/
As you say, on withdrawal the first 20k is taxed at 0%, but the next 20k is taxed at 10%. Why pay 15% now, when you can pay 10% or less later?
If your marginal rate drops below 15% due to Solo 401k contributions, then your idea of contributing some funds to a Brokerage account is sound (pay 10% tax now instead of 15% tax later.) If you live in a State that taxes dividends though, you may still do better with a Roth than with the brokerage account. Or maybe you end up with both
What do you think about taking SEPP pre-59 on your 401k vs rolling it into a Roth?
For people 49 years old and older, the SEPP path probably works well if you have limited savings outside of a tax deferred account
If you are much younger then that, then the SEPP is quite restrictive and could even be punitive if income situation changes (decide to go back to work, a hobby turns into successful business, etc…)
But then again, if you retire much younger then 49 or so you should have a healthy savings outside tax deferred accounts, since annual contribution limits would force saving in taxable accounts as well
Jeremy, Love your ideas, thanks for outlining them here in your blog.
I feel like I’m pretty well versed in personal finance but I definitely still learned some interesting strategies — one example being capital gain harvesting. Had always done tax-loss harvesting; will need to review the options for future tax years.
One thing that you mentioned above in your original article:
“Once income and spending exceeds this level, taxes must be paid. Unless…”
You go on to explain the ~$20K ordinary income exemption/deduction and the ~$70K capital gains and qualified dividends 0% bracket. I want to add just a slight twist to make this sound even better, although it will be more theoretical than practical….
While your income needs to stay below these levels, if you choose to exceed them with your spending you can still pay zero federal income tax. This is because when you sell appreciated assets (stocks, mutual funds, etc.) you are only taxed on the gain but you have access to the basis tax-free.
So for example your annual spending could look like this:
~$20K — Ordinary income (RMA, etc.)
~$40K — Qualified Dividends outside of IRA/401(k)
~$30K — Capital Gain from selling mutual fund shares
~$20K — Basis on above mutual fund shares (as an example)
~$110K — Total available to spend
This is of course theoretical because most people that have amassed enough money to retire early wouldn’t spend this much annually. But it’s nice to know it’s available if needed.
I’m sure that you already know this and perhaps you omitted it to prevent confusion. But if anyone has the objection that they would follow your advice but want to spend more than ~$90K/year in retirement, this would provide a method to allow that and still pay no federal income tax.
-Bob
Hey Bob. Yup, any basis is tax free. And if you practice cap gain harvesting for long enough, your basis will be high.
Roth IRA withdrawals would also be tax free (Contributions only before Age 59.5)
Hi there, If my fiancé gets a pension of 50k a year, does this pretty much throw all these strategies out the door once we are married? I am almost at the point of financial independence, but with his pension we would always be at higher income levels. So how much harvesting of dividends and capital gains could be done tax free?
The 50k pension would be earned income, and fill up your 0% & 10% tax brackets (and part of 15%.) You would still have 40k plus of 15% tax bracket that would provide 0% tax on Qualified Dividends and Long Term Capital Gains
Also, on a related point:
If one spends all their time accumulating funds in a 401k, then how do you take advantage of the 72k of capital gains at 0%? All the reading seems to infer that you have a big nest egg in a taxable brokerage account. I am in a higher-income bracket now while accumulating so look for any deferred tax strategies now to lower my tax rate (sounds like you agree with that strategy per prior post). But that means nearly all of the assets are in 401k/403b etc over the time.
Let’s say I retire tomorrow. Using your strategy of converting a small amount per year to a ROTH (like 10k) would still not cover my annual expenses (let’s say 70k). How do you manage to get the extra money into accounts that would not charge tax for capital gains, dividends, or withdrawal? Should I start diverting some of the potential monies that could be directed to tax-deferred accounts into taxable accounts instead (i.e. forgoing the tax break now)? Or does your strategy assume that the high rate of savings (like 75%) means that there will be extra amount of cash that can be directed to taxable brokerage accounts? In my scenario, I contribute the max that I can, but it nearly all goes to tax deferred:
– a 401k at work (17,500 plus 8,750 matching)
– plus a solo401k for additional self-employment income (about 20,000)
– and a ROTH (5,500). I do this via traditional IRA (using after tax dollars, since am over income limits) and convert it to a ROTH immediately.
Thanks for tips. This has been illuminating. I will probably work for more years, because I love my job and prefer more cushion, but want to make sure I am using good strategies. I’ve always lived on less than 1/2 my income and its way better than fussing over market returns!
An individual is limited to 18k of 401k contribution in 2015, so the combined employee contributions to work 401k and solo 401k is 18k (not twice that, as implied in your question.)
If a household is saving 75% of income, in most cases they will inevitably end up with funds in a brokerage account due to the contribution limits.
In deciding whether to save pre or post tax today, compare the marginal rate you expect to pay today vs the future. If they are the same, pre and post tax are basically equivalent.
What about Primary Residence?.
I continually read, literally every website I go to including the IRS website..
” The Long Term Capital Gains Tax Rate when selling your home is determined by the tax bracket you are in based on “Ordinary Income”.
So, if you are in the 10%- 15% tax bracket your Long Term Rate will be 0%”
There are only so many ways you can interpret that. I am selling my Primary Residence of 25 years in 2016 and I will have very little, if any, ordinary income placing me in the 10% tax bracket.
Is my LT Gains Rate really 0%?
Read through IRS publication 523. If it is your primary residence, then gains up to $250k single / $500k married are tax free. Ordinary income is not a factor.
Hi GCC,
Love your work, and we are actively working toward many of the strategies you espouse. We target saving 65% of our post-tax income this year (and giving away 10% on top of that!), with a time horizon of ~5 years remaining to be able to comfortably cover living expenses via dividends & a small annual % withdrawal from our after-tax accounts.
Question I’m trying to figure out – what about the impact of State taxes on this sort of income? Looking at states like Oregon and Idaho, I wonder (worry) whether there could be a 4-8% tax on income, even if it is highly efficient dividend and long-term capital gains. We live in TX now (no state tax), but for many lifestyle enjoyment reasons have our future eye toward the northwest.
So – if we (MFJ) stay just below the Fed Tax thresholds (i.e. accomplish 0% tax owed), would we be subject to the State Tax levies as well? I don’t want the tax tail to wag the dog, but I do want to be prepared as we head toward executing our dreams.
Thank you for all you do to compile information & challenge the norm!
Yes. If you live in a State with an income tax, you will be required to pay taxes.
Washington State shares a border with both Oregon and Idaho and is Income Tax free.
Hi there! Thanks for this interesting blog and article. You provided a lot of great advice, and it’s wonderful to see you making your dreams come true!
There were a few posts that disagreed with the stance on taxes, but one person commented that you “front-loaded” your taxes during your working years and, thus, have paid your dues (so to speak). I am curious about your comments on health insurance, though, which relates a bit to taxes. This is meant to be very respectful — just trying to understand because I don’t think I agree. You wrote “One item to be careful of is new with the Affordable Care Act. It is possible for an early retiree to get massive health insurance subsidies…At our $36k per year spending level, we qualify for several thousand dollars of assistance”. Folks who are still working and paying taxes are the ones contributing to the ACA and, thus, to such assistance programs. Even if you contributed to taxes early on in your working career, you have now brought another little being into the world — I’m sure a cute little guy at that — but one who nonetheless requires healthcare. Is it really fair to be taking assistance from those who do pay taxes while no longer contributing yourself? I understand that you feel you don’t use services (e.g. roads, though some pointed out that taxes go to plenty of other services), but you are using US-based healthcare and taking taxpayer-funded assistance. That assistance is really for people who can’t afford healthcare. Your spending level is well above poverty level in the US. Again, I am just curious and ask this with respect, but how do you justify using this advantage that taxpayers fund?
Thanks again for the really insightful and thought-provoking blog! Best wishes on your journey!
Hi Suz,
I’ll share some thoughts, and you may still not agree, but first I need to correct a few false assumptions:
> you are using US-based healthcare
This is not correct. We haven’t been in the US for more than 3 years.
> your child nonetheless requires healthcare
We’ve paid cash for all health needs to date. It is interesting how health systems outside the US that offer up front transparent pricing are reasonably affordable. The US system is broken.
> That assistance is really for people who can’t afford healthcare.
This is not correct. The ACA is not an assistance program, per se. Medicaid serves that purpose. The ACA is intended to subsidize everyone with incomes up to 4x the poverty level. A family of 3, with 401k & IRA contributions, could earn over $100k/year and still receive subsidies.
> Folks who are still working and paying taxes are the ones contributing to the ACA
This is not correct. The ACA is funded by taxes on the healthcare industry, reductions in Medicare payments to hospitals, and taxes on people making $250k+/year. The majority will receive subsidies even while working (~85% of households purchasing insurance on an exchange in 2015.)
With that as background, let’s assume that we were in the US. What would we do?
We would buy health insurance on the exchange, as legally required, and also because not having health insurance in the US would be irresponsible. I would prefer to purchase an HDHP, but the ACA requires we purchase more coverage than we need.
By purchasing an ACA policy we would receive a subsidy, per the letter and spirit of the law.
I would also vote for politicians with goals of improving the US system (price transparency, group negotiation of pharmaceuticals, insurance competition across State lines, etc…)
> Is it really fair?
What alternative are you proposing?
Should we intentionally ignore tax deductions that we are legally entitled to? After taking steps to maximize tax burden, should we also send an extra check to the US Treasury? How big should that check be?
At the same time, even though we have qualified for Social Security and Medicare at Age 65, should we refuse these services when the time comes? Are there any other government services that we should refuse?
Will you do the same?
Respectfully,
Jeremy
I don’t fully agree with your stance on taxes still, but I can respect where you are coming from. Regarding healthcare costs here (US) I fully agree with you that our pricing is beyond broken. However, you mentioned interstate insurance sales and I’m curious as to why you support that? From what I have seen I think that would be a bad policy as it would give a huge incentive for health insurers to relocate to a small rural state and sell those low cost plans (for the insurer) to other states with entirely different demographics and population pools. This podcast goes into it a fair amount, plus examining the few states that already allow it:
http://www.vox.com/2016/3/11/11199744/weeds-productivity-slowdown
Its the second topic, around 43:00 in.
What happens today if you are diagnosed with a major illness, and the world’s leading expert for that illness is in another State? Most likely visiting this expert would be uncovered by your insurance, or best case be out of network with unlimited out of pocket.
I want one policy that covers me anywhere.
That scenario will not be fixed by interstate insurance buying because that is a problem with healthcare pricing, not healthcare insurance. That can only be fixed by reforming the pricing structure of healthcare, which IMO can only be addressed effectively at the Federal level. Personally, I am a huge fan of all payer rating for this purpose and I think it is politically feasible to do in the next 4-8 years.
Jeremy, I disappointed to read you statement above about taxes, and skimming through the comments, equally disappointed to read some of the comments.
Don’t be apologetic. Taxes are theft. They are the major fulcrum of population control and how the politically connected stay in power. Paying taxes is certainly not being patriotic and to say so belies brainwashing. To the contrary, it is patriotic to reduce your taxes to as low as possible and zero is the most patriotic.
On Obummercare, that is another control mechanism. The whole health insurance industry in the US is a disaster because of gov’t intervention. All the laws and regulations should be scrapped and we should all pay for our own medical bills either out of pocket or with our own health insurance. The only patriotic act in this case is to get outside the Obummercare system, which you have done. Good for you.
Taxes and regulation are theft. Taxes and regulation are to control the masses and keep the powerful in power. Striving for freedom by avoiding these control measure is nothing to apologize for. Go Curry cracker.
No worries, I’m OK with people being disappointed in me.
Not trying to be a co-signer here, but I rarely run across anyone that agrees with my stance on taxes being theft. Got into an argument last night with a brainwashed individual about taxes. I don’t believe in marriage, but if you’re single, and around my age. I’m available. For single people like me, paying zero income tax is almost impossible because it’s only 10k/37k vs. 20/75k. Huge difference.
GCC,
Excellent information here. However, I have a few questions about saving:
1) I make too much to contribute to ROTH, so I have to contribute to traditional IRA and recharcterize the contributions to ROTH, but I do not get the tax deferred benefit due to the low income restrictions. Would you recommend putting the money in a taxable brokerage account, or keep contributing the $5500/year to the traditional IRA and recharcterizing to the ROTH?
2). What’s the right balance between tax-deferred, tax exempt, and taxable accounts? Do you recommend maxing out 401k/HSA first, then ROTH, and then taxable brokerage account? Also, I recall you recommending 3 months of expenses in cash. I currently have around 20 months, what should I do with these funds ($40k)?
Hi Hokie09
I only share what we do and why, so I wouldn’t think of anything I say as a recommendation. I don’t know the whole picture.
You do benefit from the tax deferral in the Roth. Those funds grow tax free for life. You just don’t get a tax deduction today.
I outline near the bottom of this post which order I would contribute to the different accounts. This was written with the idea of targeting early retirement, as we will have years of no earned income before typical retirement age.
If your income limit is too high for direct Roth contributions, you are in a high marginal tax rate today. In retirement, your marginal rate would presumably be lower. Based on those assumptions, standard industry guidelines are to take the tax deductions available to you now and contribute to Traditional accounts.
re: cash. We keep 3 months of cash because our dividends are on a quarterly schedule, and they are enough to pay our own bills. I explain why here.
If you agree that 20 months is too much, then perhaps add them to your portfolio per your target asset allocation.
Best
Jeremy
Using the backdoor ROTH isn’t even an option for some. If you already have an existing IRA, then you’ll likely have to pay taxes on the conversion (or a portion) because the existing IRA balance is calculated in the mix. I have an existing IRA and just looked into doing this myself. I hate to say it, but leaving money in an existing 401k is better if you make too much but want to contribute to a ROTH using the backdoor method. I hate 401k’s because it’s not at arms reach and limited investments. Most of my nest egg is in a brokerage, but I was looking at ways to have tax free growth down the line.
Open a Solo 401k for your side hustle, and roll your Traditional IRAs into the solo401k.
Now you can do a backdoor Roth.
Need a side hustle? Try driving with Uber or maybe Start a Blog.
Listening, for the second time, to y’all’s podcast with Paula Pant and J. Money. AWESOME!!!!! Congrats on y’all’s success, and thanks for the info on the tax strategies.
Thanks Keith! Paula and J are great; they do a terrific job of sharing all of these ideas.
Great and inspiring post. Just a couple of points perhaps are not 100% clear.
“Why not sell some extra stock, locking in that $34,700 gain, and immediately buy it back to raise our basis.” Did you mean ‘buy is back after 30 days’? If you do it immediately, then it would be a wash sale and you wouldn’t raise your basis.
Regarding “the $17,000 for 401k contributions”, would you have to count that as cost of living, since you have to put this amount aside instead of spending it on the beach? In other words, you raise your deduction and pay no taxes on this amount, but you don’t get to spend it either, hence my reluctance to see it as part of your income every year.
There is no wash sale for gains.
Thanks for the blog and post. I’m a little unclear on “buying back the etf” – why would you sell it just to buy it back immediately? I missed something here. Sorry I’m a little slow..
It raises your basis tax free.
I would love to hear from you how your retirement strategy would work for a non-US person, that invests pretty much like you (VT, VTI, etc.).
Works the same, but you may have US tax burden.
Great information, and I love how you pulled all of this together.
Have you, are you planning on sharing your spreadsheet you use to optimize taxes? It seems like it would get pretty tricky quickly and I am curious how you laid out your plan.
Thank.
I don’t have a spreadsheet that would make sense to anybody else. But I did write a post about the process I use in December each year.
Awesome….. Great advice.
Does the 70,700 rule for no capital gain tax still apply as of 2016?
It is adjusted upward each year for inflation.
For 2016, it is $75,300 plus $20,700 for standard deduction and 2 personal exemptions.
This is for a married couple filing jointly. Divide by 2 for single filers.
Thank for this post!
My understanding is you can only Harvest Capital Losses from a taxable account (so you cannot HCL from an IRA, Roth, 401k).
With Harvesting Capital Gains, can you HCG with any account including IRA and 401k?
You cannot HCG with a Roth because you don’t pay taxes on withdraws anyway, correct?
Thank you!
Hi Robert
You can only harvest gains and losses in a taxable account.
Great post. And I’m impressed that you still check comments on these older posts. Thank you for sharing your knowledge with those of us still on the path to FIRE.
I hold Vanguard VTSAX and recently harvested some taxable gains into VFIAX. I’d like to get the money back into VTSAX as soon as possible, but will probably wait 1 year to avoid short term capital gains tax.
I believe you hold VTI. When you harvest your capital gains/losses where do you exchange to, and do you hold it there for 1 year?
My pleasure, tbfa.
I’m usually doing gain harvesting as part of portfolio rebalancing (sell what is up, buy what is down.) Last year this was sell VTI buy VXUS.
But there is no wash sale rule with gains / no requirement to buy something substantially non-similar / no reason to wait a year. The wash sale exists on losses because the IRS doesn’t want you to offset earned income by too much. But with a gain… that money is taxable today, now. It just happens that the tax rate is 0%. There is no reason to put rules in place to prevent people from creating taxable income.
Great post. Seems taxes gets everyone’s attention. Frankly, I don’t mind paying taxes as long as they do good in a country such as fund education, healthcare, retirement, defence, and infrastructure as compared to constant warfare that benefits corporate billionaires (who seem to have the power these days.)
I have been retired for over 22 years and have not paid taxes over that period (as I recall), although I did pay my fair share for nearly 35 years. And, theoretically, I live in a high tax state (Oregon). How did we do it? Income less than $50,000 a year.
Our income has actually decreased during the past 20 years in retirement so that we depend on Social Security as a major portion. We rarely have made more than $50,000 a year in retirement, yet due to favorable tax laws in Oregon for seniors and at the federal levels, we have major deductions that have resulted in zero taxes.
We recently came back home after traveling for 12 years around the world, five years teaching ESL in the Middle East, and seven years full-time RVing in the USA and Canada. Loved both activites. I lost my pensions through a divorce and a company bankruptcy, so not what we expected. Totally agree with your Roth IRA planning.
As a last resort, I have worked part-time on a seasonal basis for the past five years doing fascinating things such as selling Christmas trees, Amazon.com Fulfillment Center, Camp Hosting, Wine Demos, etc. Actually, it’s been a lot of fun and keeps me sharp at age 80.
I was a travel professional for 20 years with my own company, so have been around the globe many times.
Long story short…”Man Plans, God Laughs”. It seems there is always an opportunity of making lemonade out of a lemon, regardless of one’s age.
Sounds like a wonderful life. Thank you for the inspiration. I hope I can be as spry and worldly at 80.
Pinned this post for future reference.
Hubby and I have 7 kids and earn too much money to qualify for any ACA subsidies, thanks to ACA our health insurance premiums skyrocketed from around $200 to over **$600** a month (just for the two of us!), so we cancelled it and went with Liberty HealthShare.
Our HCOL (because 7 kids) means it’s hard to use any of these strategies, but our long-term plan is to : pay off the house (we have no other debt) in 15 years or less, invest like crazy with our money now, reduce self-employment work hours/income (we’re both self-employed) to cut income to beans and rice levels. Then, pay no taxes.
Hi , just found your site , think it’s excellent
Have you or any of your readers any knowledge of European take on the Tax situation?
We live in Greece for part of the year , and travel for the rest , never in any country over 180 days , so tecnically not tax resident anywhere , now our bank is asking for a CRS form that requires a tax number , would like to know others views on this one
Hey Jeremy! Thanks for this post. I’ve bookmarked it cause I know it’s important, but to be honest, I need someone to talk to me about this tax stuff like I’m a 10 year old. I’ve been reading a lot from Mr. Money Mustache, Mad Fientist, and jlcollinsnh for the past couple years, and while I feel like I typically grasp these concepts quickly, I get lost when it comes to taxes. I’m 34 and want to set up my tax situation correctly, but I don’t really know how to do that. I’ve got a 401K through my employer (with Vanguard), but how do I go about setting up an IRA or a Roth IRA? Does Vanguard do it automatically when I open up a new account? I understand that one is funded with pre-tax dollars and taxed when distributed and the other is taxed with post-income tax dollars and distributions are tax free, but how does one go about setting it up and what is the appropriate time to be funding these accounts? Do I need to be tracking contributions/distributions or will I received a tax form in the mail that details all of that for me? Do I need to worry about it now or should I wait until I’m ready to “retire”? I’m sure one of you financial bloggers has addressed this in some post somewhere, but I just can’t seem to find something that will walk me through it step-by-step and I don’t really want to pay a tax accountant to do it for me!
Hi Ryan, a book like The Boglehead’s Guide to Retirement Planning (available from your library) is a good place to start.
Hi there – can you provide clarification/insight on how this applies when one is over 59.5 years old and have access to tax deferred accounts penalty free?
When researching spending order, most articles default to spending down taxable accounts first, then tax deferred in order to pay the least amount of taxes. But I think with the strategy you have outlined, one can actually access tax deferred accounts and still not pay taxes.
Example; married filing jointly with 1 child (minor) in 2017. One spouse is >59.5 years old.
Personal exemption: $4050 x 3 = $12,150
Standard Deduction (MFJ): $12,700
TOTAL: $24,850 –> so technically I can get this we can get this from the tax deferred account.
And then we can make up the rest from the taxable account, up to $75,900 of long-term gains and/or qualified dividends.
All of this $100,750 ($24,850 + 75,900) are completely tax free?
Thank you for your help and I apologize if this questions is elementary.
You got it.
One of my favorite posts. I come back and read this one from time to time and it makes me happy. Way to go GCC. Hopefully the rejiggering of the tax rates doesn’t kill the 0 taxes on your dividends.
Inspirational and well written. Definitely one of the top finance bloggers out there. I would love to implement the ROTH IRA conversion plan. I look forward to future posts!
Jeremy, really appreciate your insight on this! Taxes are such an important piece of the FIRE equation. I was wondering if you would be able to clarify something for me? This is a hypothetical I am planning for in a few years. I’ll try to be brief…
When my wife and I retire we will be in our mid 30s possibly with kids, but let’s assume no kids for this hypothetical. So, using 2017 tax rates, here is my baseline plan:
Earn roughly $11k side hustle income (dump into IRAs). I know we could use the solo 401K or something similar for bigger contributions but, hey, I’m gonna be retired. I don’t plan on working much! So let’s say we make exactly $11K. We would then utilize the Roth conversion (props to Mad Fientist on this!) up to our standard deduction and exemptions – $20,800. After that, we would take in dividends and sell enough LT cap gains so that the total between the two would be $75,900. Based on my understanding of your above mentioned strategies, this would essentially lock in $107,700 tax free (at least on the fed level). Does this sound accurate? Appreciate any feedback you can offer.
Sorry, based on the date of this article, I seem to be a little late to the party ;)
sounds accurate :)
HI Jeremy,
Thanks for the nice summary. Question on the $17,000 tax free contribution limit for 401(k). For a married couple, shouldn’t the contribution limit apply to each adult (husband and wife)? Hence, the untaxed income level would be $53,500 ($19,500+$17,000+$17,000) instead of the $36,500 for a married couple (given both husband and wife are working). Am I forgetting something?
Thank you!
Other deductions can be applied… 401k (his/her 401k if both work), HSA, Traditional IRA, employer contribution to solo 401k if SE, etc…
Wow! After hearing you on Paula’s Afford Anything, my mind was blown! Major kudos to you, Jeremy and Winnie! Totally inspired. I’m continually seeking to learn and understand more.
My main questions, and I read the comments to see if it had been answered, is why does spending have to stay below a certain level (i.e. $36,500 at the time of this blog) if the income off your investments can be/is much higher (i.e. $70, 700)? What happens if I spend over the $36.5K if what I’m spending is qualified dividends or LTCG ?
Sidenote, I think it’s so awesome that you still respond to comments written years after the original post! That shows the value received and provided.
Thank you kindly, I’m blushing over here :$
You can spend $100k +/- per year tax free if income is from divs and gains.
I have been reading about the FI/RE movement for a few years now (and trying to participate, but at a more modest level). I experienced a renewed interest in your blog and story after listening to the Podcast “Afford Anything” where the two of you were interviewed. The “never pay taxes again” part was fascinating. Unfortunately, I don’t think it’ll work for me in Canada. I don’t think RRSPs and be converted to TFSAs. Also, all our capital gains are taxed at 50 % of the realized gain and there is no 0% tax bracket.
If I’m wrong about this, maybe you or one of your knoweldgeable readers can correct me (because I would LOVE to be wrong on this one).
Regardless, thanks for your inspiring story and for all the good work that you are both doing.
I don’t think it works in Canada.
This was a fascinating article, Go Curry Cracker. Thanks. I hadn’t thought about tax gain harvesting, I have to confess. Does you have thoughts on whether it makes more sense to prioritize converting Traditional IRAs to Roths until you hit the bump up from 15% tax bracket to 25% vs. prioritizing tax gain harvesting? I’m thinking harvesting tax gains should take priority because locking in the higher basis could prove fleeting–while converting to a Roth is always an option. But I welcome your thoughts!
Thank you kindly.
Rather than think of it as a conversion vs cap gain harvest tradeoff, think of it as marginal rate optimization. Prioritize the 0% tax rate, and only choose to pay tax at 10% or 15% if it avoids 25% rates later.
Makes sense. Thanks.
Dear Jeremy,
God’s peace upon you. On a taxable income of 38 k now paying 0% income tax, could you please detail a regular to Roth IRA Conversion plan, with tax implications at various amounts. I’m 53, FI for years, still “working” overseas. No plans to spend from investment accounts any time soon.
Blessings
Hunter
Hey Hunter, take a look at the example outlined in our tax return. That is the best way to come up with an individual plan.
Just caught your guest appearance on Choose FI podcast and stopped in my tracks with the conversation about selling equities to raising your basis. I’ve read this particular post of yours before, but it didn’t resonate the same way that it did today. Although I am still working, I am currently stationed overseas in an area where 100% of my pay for 2018 will be tax free. I’m sitting on about $16k of unrealized long term cap gains and $4k of short term unrealized cap gains in taxable accounts and assuming they are still a gain nearer to the end of 2018, I fully intent to pull the trigger, sell, and repurchse to raise the bases on these holdings. The short term gains should also benefit in this case since again I’ll have $0 of taxable income in 2018. Thanks so much for sharing your insights and tips; it will be immensely appreciated in my soon-to-be-early-retired state.
Hi Gcc, would you mind taking a shot at how this will look for Tax Year 2018 (i.e. paying one year from now) in a new article? Also, have you ever thought of walking through your tax returns on YouTube with some type of screen recorder, with commentary on how you thought through the lines? Sometimes talking about it out loud recalls your mental state at the time which can reveal a lot more of the meta-thinking.
Hi JPM. The principles are all the same, the only thing that has changed is the numbers have increased for inflation.
I like the YouTube idea… maybe something to do for this year.
Hi GCC, thanks for the article. I still quite understand about ‘harvesting capital gain’. This only applies to regular brokerage account? since 401K and regular IRA accounts are tax deferred, you have to pay tax on ALL money you withdraw. So raising basis doesn’t matter?? Also, you do this when you near your ‘retiring’ year? Can you please explain this ‘harvesting capital gain’ a little bit more?
I agree on YouTube idea of JPM. A little more explanation on how things work would be greatly appreciated. :) Thank you!
I’m so curious to see how your calculations/strategy changes for 2018. Will you be doing an update post earlier in the year?
I will do a post this year (2017 tax year) in April or May most likely. The strategy is unchanged.
Looking forward to your 2017 tax prep. I guess I’m not doing enough bec I owe about $7K in taxes as a single with wages of only 80K, too little withheld seems like :(
Would like to see more ideas to reduce my taxes. 20k to 401, and $7400 to HSA for 2017 just didn’t help.
Have you ever used the Retirement Savings Contributions Tax Credit? If I’m understanding it correctly one only needs to keep their AGI under $38k (2018 MFJ) to be eligible for the full credit, which is 50% of contributions up to $4k, meaning a $2k tax credit. With the 2018 standard deduction of $24k, an early retiree could withdraw up to $38k from Traditional accounts (for spending or Roth conversions), resulting in $14k in taxable income. If one could also obtain at least $4k in earned income, contributing all of it to a Traditional account (to maintain sub-$38k AGI), the Saver’s Credit would completely offset the $1,400 in taxes that would have otherwise been owed. Now this would prevent you from tax gain harvesting as any realized gains would push your AGI over the limit, but it seems like a good “Never Pay Taxes Again” strategy for those whose ‘stache is primarily in tax deferred accounts or are prioritizing tax free Roth conversions. I’d love to hear your thoughts!
Well, it looks like there is some fine print (of course there is!) on the Savers Credit. One pertinent piece is that you must deduct any distribution from a retirement account made in the 3 years prior from the contribution that you are claiming for the Savers Credit. A Roth conversion doesn’t count as a distribution so you could still use this strategy when first setting up a Roth conversion ladder, however as soon as you need to actually use some of that retirement account money (presumably after the 5 year waiting period) it is much harder to use the Savers credit.
Also, I realized that contributing to a Traditional retirement account in the same year as making a Traditional to Roth conversion doesn’t really make sense. One should instead fund the Roth directly with any earned income, reduce the Roth conversion by that amount, and avoid the 5 year waiting period for that particular contribution. I’m enjoying this conversation with myself!
Looks like you are getting it all figured out. Also check out the forum for discussing a wide range of topics with the whole GCC Community.
Thank you for this great article, wish I had read it earlier, but it’s never too late to learn.
I have question about Qualified Dividends. Do you try to manage qualified or ordinary dividends in order to control your annual income? I found it hard to plan for (or anticipate) dividends.
Yes and no. We can invest primarily in US funds to get the majority of income from qualified dividends, but it is never 100% controllable.
Hello,
I am 20 y/o and have two jobs I plan to do at different times one is to be a nurse and the other is to teach abroad they have vastly different incomes and i was planning to do the one with the lower income first but I might get bigger tax brakes because I will be overseas. Should I do the opposite and wait to do the lower income job. And with that should I still Traditional IRAs while working even though my income will be at barley 20 grand?
Great! I wish I had been thinking about this stuff at age 20.
There is no right answer to this, and not enough information here to say for sure one way is better than the other. The best answer may be to do whichever you prefer.
It isn’t so much a question of how much you earn but how much you save. If you can save more with the higher income job up front, then those savings can grow while you work a lower income job.You might get bigger tax benefits while overseas, you might not. It can depend on where you are working.
Hi! Thank you for sharing all that you have!
I have a couple of clarifying questions regarding type of accounts and harvesting capital gains/losses in your post. To apply a capital gain loss of $3,000, does that only apply to taxable investment accounts and not tax-deferred (401k and Trad. IRA) and tax-free (Roth IRA) accounts? If not, in what circumstance do you deduct that loss in one of the retirement accounts? Is it only when you want to offset your gains during an early withdrawal? The confusing part is that you don’t mention a withdrawal, just only the selling/buying of stock. Yet, I thought retirement accounts don’t require you to pay taxes on your gains until after you retire and begin taking distributions. Or is this last statement only true up to the $70,700?
Additionally, I read that there is a 10% penalty fee for an early withdrawal in additional to ordinary taxes. How does the penalty fee factor in? Do you reduce your ordinary income by the amount of the penalty fee to ensure you remain untaxed?
I am late to the investment game and certainly have a lot to learn. Thank you so much for your help!
It is true that you will not pay capital (or any other type of taxes besides withdrawal taxes) on traditional IRAs and 401(k)s, however, in order to retire early, you need money that you can access before 59 or 55 1/2 respectively. If you try to use money from those retirement accounts before that age, you will have to pay a 10% penalty along with whatever income taxes (federal and state) that might apply with your distribution. With Roth IRAs, you can access the principal (not the gains) after five years of either a rollover or initial deposit without paying a 10% penalty.
Now that may not be enough to sustain you, so it may be necessary to do after-tax investments. In fact, after-tax investments are necessary to reduce the risk involved with your pre-tax IRAs and 401(k)s that are meant to grow on a much longer term. Enter capital gains on after-tax investments. The selling/rebuying of stock for capital loss harvesting is for after-tax investments.
You can access all 401k and IRA money penalty free at any time. See 72t / SEPP.
You can also access Roth IRA contributions (initial deposit?) at any time penalty and tax free.
I know at the federal level you can do the harvesting capital gains for 0% tax, but what about at the local level? How were you guys able to not pay any state/local tax on the long term capital gains? I looked up a calculator online and it added up to still be about 10% after state and local taxes.
Live in one of the 7 States with no income tax.
Hi! Thank you for sharing all that you have!
I read that there is a 10% penalty fee for an early withdrawal in addition to ordinary taxes. How does the penalty fee factor in? Do you reduce your ordinary income by the amount of the penalty fee to ensure you remain untaxed?
I am late to the investment game and certainly have a lot to learn. Thank you so much for your help!
We’ll never pay a penalty.
There are numerous penalty free ways to withdraw funds from tax advantages accounts.
Amazing post. I can’t imagine how many people whose lives have been changed by this post alone.
Do dividends take care of all your living expenses? Or do you have to sell some shares every once in a while? If you do have to sell shares, which do you sell? I.e do you sell the shares with the most unrealized gains first? Or do you the opposite?
The yield on VTI / VTSAX is only about 2%, and people expect to live by the 4% rule. So dividends won’t cover living expenses for most. Selling shares is the normal and natural solution.
Which shares you sell depends on many factors, including taxes. If you can sell the shares with the greatest unrealized gains, then do so. Or maybe you sell shares that have no realized gains. Or maybe harvest some losses. Whatever method results in the best tax / cash flow / asset allocation outcome.
This is a great read! With the new tax codes in effect, I’ve become much more focused on transitioning to early retirement. Few things I was hoping for clarity on, My wife and I have 2 kids and own our primary residence. In this case would the $24k be adjusted upwards for 2 dependents ($4050 each) along with the addition of property tax? (so 24000 + 8100 (child exemption) + 8000 (property tax))? Also lastly how does the child tax credit come in? We have two under 17 so i’m assuming I can earn another X amount of money to be offset by the $4k in child tax credits?
$24k is fixed. Dependents don’t change it. Personal exemptions no longer exist.
https://www.gocurrycracker.com/tax-reform-early-retiree/
Property taxes aren’t deductible unless you itemize, which would require deductible expenses of more than $24k.
CTC is $2k credit per child. You can take this as cash back, or you could “earn more.” I’ll goose my annual Roth IRA conversion by a bit this year to then be offset by the CTC.
Hi Jeremy, the “old” IRS rule was for 0 taxation on LTCGs if the overall income was in 15% or less brackets. With the new bracket being 12% instead of 15%, have you found any specific info from IRS on how the taxation of LTCGs will be performed now? Many of us assume that the rule will be the same (just change 15% to 12%), however I was unable to find anything concrete from the authorities. Thoughts?
It’s still about the same value, they just decoupled it from the tax bracket. You can always find the exact value on the qualified dividends and capital gain tax worksheet
Right, I just haven’t been able to find that worksheet updated for 2018 tax year.
Being newly (and early) retired and going on ACA, as well as my determination to get the *maximum* healthcare subsidy I possibly can, and with 8 yrs to go until Medicare, I’m constraining my taxable income (maga) in 2018 to under $13K. That means a trade-off since I am getting dividends and interest. I calculated I can only convert about $9K this year from IRA to Roth or else I’ll go over my maga limit for my ACA number. If you want the cheapest healthcare cost, then you will have to give up some $$$ conversions to keep your taxable income low.
Yes, it is a trade off. Math here.
Great post! Newbie here. Question for you, if you’d be so kind! So my parents started a Roth for me when I was a baby, (nice of them,) and it’s only been recently that I learned that this isn’t the best place for my investments. (I also have investments in a brokerage account and I’m looking into getting a Solo 401(k) and a HSA. I know I ultimately want to have a Roth later in life, so I can do the IRA conversion. But my question is, what do I do with the Roth now? Do I just leave it alone and never touch it again until I do the conversions later? Or do I try to convert it to a Traditional IRA? Or should I open a new Traditional IRA and put the yearly $5500 in there instead of the Roth? Grateful for any advice you have for me!
Hey Katie
Lots of stuff in here… You need earned income to contribute to a Roth, so presumably you had some as a baby?
A Roth is great. It will never be taxed again no matter how big it gets. Just leave it, now and forever.
There is no conversion from Roth to Traditional. It works the other way.
What to contribute to today depends on what your current marginal tax rate is and what you expect it to be in the future. For aspiring early retirees, generally that means Traditional is best (both 401k and IRA.)
So am I understanding this correctly? This is only applicable to taxable brokerage accounts? Roth obviously isn’t taxed. Traditional 401(k) and IRA‘s would be taxed at the normal applicable marginal tax bracket ( if we weren’t doing the Roth conversion ladder)
Cap gain/loss harvesting is in taxable.
0% tax rate on qualified dividends / LTCG is in taxable.
Hi Go Curry Cracker. Was turned onto you guys by Mad FIentist and respective community members. For a Roth conversion, doesn’t the 59.5 age rule still apply? Was reading https://www.irs.gov/publications/p590b#en_US_2017_publink1000231061 and I am able to discern where they discuss the distribution from a conversion, but don’t we also have to meet the age requirement? Heaps thanks!
-Chris
No. You can withdraw contributions anytime, and the full amount of a conversion after 5 years. No tax, no penalty.
Heaps thanks for the reply! Additionally, we appreciate how you guys have laid out the 4 tax reduction bullet points above. We were thrilled to read about long-term cap gains taxes. When we get to FI we’re coming back for some Central America tips. Thanks again.
Is capital gains harvesting still worth it with state taxes 5%? Also, is it worth losing the future growth potential on the state taxes (~1k) in favor of a 0.5% reduction in expense fees?
There is no right answer on this.
On $200,000 of investments a 0.5% er reduction will save you $1k every year. Or in 2 years on $100k, etc…
If you had an investment that grew 7% per year, and every year harvested gains w/ 5% tax, in 20 years the value would be about 7% less than if you never harvested.
But basis would be 100% vs 25%. If you then sold half of the unharvested account and just half of it was taxed at 15%, then you would be at parity.
Does it make sense to pull back one’s 401k contributions in anticipation of an RMD that will be more than 24k so as to be able to take full advantage ($77,400) of the basis step-up on a taxed investment account?
Look at the post, Is Your 401k Too Big?.
Seldom does it make sense to avoid current tax benefits in favor of future tax benefits. (It might, but unlikely.)
Many thanks for the detailed article! I am currently a non-US resident, but still need to pay US taxes. I currently quality for Foreign Earned Income Exclusion. Does harvesting captial gains strategy still work for me? Is the limit of 70,400 still applicable if my status is married – filing separately?
FEIE and cap gain harvesting can be used together. See here.
Single filers and married filing separately, divide by 2.
I find some of this a little far fetched. You talk about not working, but you also talk about giving to retirement accounts. You can’t contribute to retirement accounts if you have no earned income.
You talk about living off a given amount then managing capital gains and loses to avoid taxes, then talk about investing in index funds where you cannot control your capital gains.
how can you control capital gains?
Last you are not really retired. You spend a lot of time developing and monetizing your web site.
But…
You do have some good ideas. Tax loss-harvesting is a great way to avoid some capital gains tax. Tax gain harvesting is great idea if you have less that $72K in capital gains.
Give to your retirement accounts before you stop working.
You control how much you sell, so you control exactly how much gains you realize. To the penny.
I spend about 4 hours per week on this site. I also spend about 5 hours per week in the shower. Therefore nobody who showers can be retired.
I retired at 53. I’m now 54.
Mutual funds distribute capital gains to share owners. So if you have an index fund you will have capital gains, interest and dividends that you can’t control.
What does the time spent in the shower have to do with being retired? Showing does not generate income. You work to make money. You are self employed. I quit my “day job” when I was 29. I was self employed not retired. I then focused on growing a company instead of being self employed.
So one of the best approaches to retiring early is to actual not retire and be self employed so you can control your own schedule? You are a self employed marketer. And it appears pretty good at it.
living off of 4% off your saving works if you are 65, not sure the same rules would apply if you retire at 40. Unless of course you have a job that still generates income. There are lots of calculators where you input your saving, rate of return you plan to make (which people tend to over estimate), rate you will withdraw, and it will tell you when you run out of money. Do you shared these numbers with your readers? Maybe yo have a calculator on your web site that helps with this?
I’m also paid to shower. Plus hygiene is important.
You are so close to figuring this out, but it is harder to learn when you think you already have all the answers.
Wow retired and you don’t know how to relax. I guess you’re to busy stressing over how you can make a buck.
You know what they say, don’t through mud with a pig, pretty soon you’re both covered in mud, but the pig likes it.
Good luck with your marketing career.
By the way – I don’t need to figure it out. I am retired and I have the means to do what I want. My monthly budget is almost your annual budget. Maybe I should start a blog.
I just wanted to find out what you were about. You made that very clear.
Cool story bro
Very interesting!
Great post. Discovered you from JL Colin’s book. I’m still a bit confused about tax gain harvest. Is this only for taxable accounts or also in IRA’s? When you raise your cost basis, how is that tax free? From your example of $50,000 purchase in an index fund and selling it for $84,000 a year later. Then buying it for $84,000 to increase the cost basis. Does this mean you can withdraw/sell $84,000 without worrying about which income bracket you’re in? Thanks!
Taxable accounts only. The only taxable event in an IRA is a withdrawal.
You can withdraw basis independent of taxes, but if the price has increased since purchase you will have some taxable income (might still be zero tax.)
How do the income/tax values change for someone who is single?
Divide dollar figures by 2
Hello,
I’m probably reading it wrong but how do you transfer more then the limit for a ROTH IRA conversion?
There are no limits. You can convert as much as you want.
You might be thinking of contributions.
I’m not sure why TurboTax is giving me strange results. Family of 4 and I put in these numbers to see what I get:
1099-INT 38,300
1099-DIV 79,750.
Total income $118,050
Federal deduction $24,000
Federal credits $3,961
Federal taxes you owe: $0
Is this correct?
seems right
Could you briefly explain why? My guess is foreign income exclusion?
The foreign earned income exclusion only applies to earned income. Interest and dividends are neither foreign nor earned.
Using 2018 #s:
About $24k of the interest would be taxed at 0% due to the standard deduction.
The rest of the interest would be taxed at a 10% marginal rate ($14,300 * 10% = $1,430.)
Most of the qualified dividends would be taxed at 0% (up to $77,200.)
The rest of the dividends would be taxed at 15% ($79,750 – $77,200 + $14,300 = $16,850 * 15% = $2527.)
Total tax: ~$3,960
2 child tax credits: ~$4,000
Total tax burden: $0
Wow! Nice work. The $14,300 of interest is taxed at 10% but I see that you have it also taxed at 15%. Can you explain why it is there twice?
These two lines:
10% ($14,300 * 10% = $1,430.)
15% ($79,750 – $77,200 + $14,300 = $16,850 * 15% = $2527.)
It’s not – it reduces the amount of 0% tax-free dividend space you have. You can think of it as pushing more dividends into the 15% bracket.
Got it. I’m getting a hang of this. This is really interesting. I was able to play around with TurboTax and I was able to get a family of 4 with the following numbers:
1099-INT: $24,002
1099-DIV: $103,867
Total Income: $127,869
Federal Taxes you owe: $0!
If it is right then you should update your post to state that you can have a income of $38,300 without paying taxes instead of $24,000. Am I missing something?
You are getting $4k in child tax credit
I would expect for you to owe about $150 in taxes (which is still not bad on $118K income!). Perhaps you made some estimated payments during the year, or some taxes were already withheld?
I’m just playing around with the numbers in TurboTax. Those are the only two numbers that I put in – interest income and dividend. No taxes withheld.
I just listened to your podcast interview on Choose FI from April 2017. I’m starting to study this route, are these methods still in play with the new tax laws over the last few years?
Yes, still the same.
Love your stuff here. Any tips on rental income? I’ve got a nice set up with about 138k largely offset by depreciation, but need to reduce salary taxes as well. Rental income not considered passive .
Never Pay Taxes Again Using Rental Properties.
Wow Thanks for the awesome stuff! I am reading this in Nov 2019! I am bit confused regarding the buying back to raise your basis tax free. Why do you need to buy it back ? Would you mind elaborate a bit on this?
Wouldn’t you worry that this mutual fund will plummet or slowly go down?
You buy it back because it is part of your desired asset allocation, you just want higher basis for lower future taxes.
Hi Jeremy thanks for this insightful post! I recently read the book ChooseFI where the guys mentioned your strategy on contributing to tax deferred account over Roth accounts. So far in my FI journey I thought the Roth 401k was the way to go. After reading your post, I’m still a bit confused about how traditional 401ks are taxed at withdrawal. I believe it’s taxed as ordinary income so is the strategy to only withdraw up to the 24k standard deduction when you have no other working income so it’s taxed at 0%? If it was a taxable account I’d could see how it would be taxed as long term cap gains but since it’s a traditional 401k. I’m not seeing how I could withdraw more than 24k without being taxed ordinary income. Thanks again for the post and I’m loving all the recent content as well!
You have it right. ~$24k taxed at 0%. Then next ~20k taxed at 10%, and next ~$60k taxed at 12%.
GCC- thank you so much for your excellent posts- we admire what you are doing! Question is what process/math do I need to go about coming to an answer for our situation on this question given our high retirement savings and expected income during retirement? According to my figures, our tax burden later with Trad TSP makes it better to go Roth TSP. Background- Hubby and I have about 20% of our $760k in the Roth TSP and the rest in Trad TSP. We have 2 years to work before ER at ages 48 and 50 and will continue to max out contributions to our TSPs and backdoor Roth’s. Gross pay together is $240k (plus pay off the mortgage). We figure we’d like to spend about 60k/yr in retirement. We’ll start collecting deferred retirements at ages 60 and 62 expected at $34k a year and SS cut in half at $12k a year. We plan to do the 72T SEEP and Roth conversion Ladder in ER, drawing down some of the TSP Trad, but according to our figures, I’m worried our “income” will put us at least in the 15% bracket If not higher as we start collecting the pensions, SS, and eventually RMDs. I’m kind of stuck on how to do the calculations.
Ok I forgot to say I’ve read so many ER articles and I’m trying to apply the learning. Here’s some more detail on how I’m figuring all this. Do you think these methods are sound? Through all years after working I’ve tried to keep us in the 12% income tax bracket so as not to cause a huge tax burden later. Our target is to keep income below $60k before we turn 65 when Medicare kicks in to get 350-400% FPL subsidies. Income during those years will be by TSP Trad (72T and Roth ladder conversions and then regular conversions once age 59.5) and some dividends and spending from taxable account. We’ll also spend our Roth TSP down by about 2/3 during those years if we want for enhanced lifestyle. Pensions kick in at ages 60 and 62 so TSP Trad conversions will slow somewhat at that time but essentially TSP Trad will be zeroed out by age 72 or so. Around that time we spend down TSP Roth and taxable accounts completely and then the last 20 or so years we’ll spend down Roth IRAs. This was figured with our last 3 years of TSP contributions going in as Roth.
For process / how to do the math, here are 2 examples:
– GCC vs The RMD
– Reader Financial Review: Scared to Death of Early Retirement
If you have questions going through it, the forum is the best place – hard to do a lot of back and forth in the comments.
Question.
Single filer gets 12K Standard Deduction for Income
Long Term Capital Gains 40K or less zero tax.
Does this mean you can have a total of 52K in capital gains and pay zero tax?
Yes, correct.
I’m trying to understand the idea of living off of qualified dividends or long-term capital gains up to $80k. I’m assuming the account you are pulling from is taxable (e.g. Schwab brokerage), correct? So you need to build up a substantial amount in this account to life off the dividends.
How Do I Live Off Just Dividends?
“Unless that income comes from qualified dividends or long-term capital gains. In this case, a married couple can have $24,400 a year in income AND $78,750 in investment income,”
I know this is a tiny optimization but In addition to the above, you could add 600$ per child if the married couple has children, right? The 600$ being the non-refundable part of the Child Tax credit:
“The Child Tax Credit is an example of a partially refundable tax credit. If the taxpayer has zero tax liability in a given year, as much as $1,400 of the Child Tax Credit can still be given to them.”
https://www.fool.com/taxes/2020/02/15/your-2020-guide-to-tax-credits.aspx
Kinda. A credit reduces tax liability dollar for dollar – so rather than a $600 increase in income you would want to generate $600 in tax, e.g. $4,000 of capital gains taxed at 15% = $600.
There are a ton of other tax credits / deductions / exemptions / exclusions that can be considered also – you can see many of them at work on our latest tax return.
Oooohh..that’s even better. Except, to take this into a different tangent, my excitement about all this is tempered by my recent realization that barring special circumstances (big cash out for buying house etc.) it mostly makes sense to stay under the ACA cliff and forgo squeezing every last drop of 0$ tax income. The math for us roughly works out to the following:
ACA monthly subsidy for staying under 400% FPL: ~$350
Annual subsidy = ~$4200
400% FPL for family of 3: $85,320
Max 0$ Income for MFJ: ~$105,000
Potential value of 0 tax Roth conversions that can be squeezed out by blowing past ACA cliff = 105,000 – 85320 = ~$20,000
Future potential effective tax rate for that Roth money = ~15%
Future tax savings by additional $20k Roth conversion = 15% of $20k = $3000
Hence,
$4200 saved today > $3000 saved when im 65.
Does this seem like a no-brainer to always stay under the ACA cliff whenever possible or am I missing something?
It might be better, might not. It isn’t a no-brainer as it depends on the penalty for going over the cliff which is dependent on zipcode, family size, and age. Insurance premiums at age 65 can be 3x age 45. But also, who knows what the US insurance system will look like in 20 years (let alone 2.)
Some additional light reading:
Obamacare Optimization in Early Retirement and the subsequent post.
I weighed some of these tradeoffs in this post and the following 2 or 3: Going Back to Cali…?
Hi, say you are single & received unemployment benefit in 2020 – for example 20K. The first 12K is your standard deduction so you would pay taxes on the remaining 8K. Do you still owe zero taxes on another 40k of dividend and long term cap gains? If so, wow, that’s great.
Yes.
*but ~32k rather than 40k.
We definitely could have done a better job of minimizing taxes during our major earning years. Sadly, that’s in the past (well, not complaining about our FIRE path!).
Businesses have a whole additional track of tax minimization strategies, too. I did put significant effort into having professionals help make sure that happened, but it’s pretty overwhelming!
All in all, it’d sure be nice if the tax code was simpler for everyone even if the tax implications resulted in the same net tax. Then again, people willing to put in the effort couldn’t take advantage…
Just getting into the FI culture. I am a frugal CPA who is 41 years of age. I learned about this site and post from the JL Collins book. Very helpful. What I am most interested in is advice around accessing tax-deferred accounts penalty and tax free. I expect that I could reach FI in 5-7 years time. 68% of my capital is sitting in tax deferred accounts. From “Quit Like A Millionaire” I’ve been exposed to the concept of the Roth Conversion ladder whereby I could convert some tax deferred IRA assets into Roth IRAs and then be able to access them 5 years later without penalty. With the bulk of my assets in Tax deferred accounts, I’m concerned that I will not be able to cover my living expenses based on withdrawals from my much smaller taxable investments. Two questions (1) How do people cover the 5 year “waiting period” whilst those IRA conversions are seasoning? (2) my spouse may continue to work her part time 20 hour a week gig which will result in earned income greater than the standard married deduction – what impact will that have on the IRA Conversion Ladder approach? Can it still be done even with some earned income? Thanks for your time and consideration – Jim
If you have a portfolio worth at least 25x your annual spending, 32% of funds will support spending for 8 years. That’s more than the 5-year seasoning window, and could get you most of the way from late 40s to 59.5. You could also setup a small SEPP for additional cash flow.
Paying no tax in retirement is nice, but the number of people able to do so is limited. If you have household income equal to the standard deduction, 100% of a Roth conversion would be taxed at 10%+. That’s pretty low – I’d happily pay 10% rather than 22%+ while working or during peak RMDs.
There are links in the post above to our tax returns – going through a few of them might help clarify things.
I am 67 and retired. My income is: Taxable interest 2,053
IRA distribution 6,750
SS Benefits 10,696 taxable 643
LT Cap Gains 7,720 (ESTIMATE)
Rental income 4,414
Total income = 31,633
Cap Gains are taxed at 0% up to 40,000. Using TurboTax I can only get my Cap Gains up to 7,720 (the estimate above). That leaves 8,367 before hitting the 40,000, but Turbo Tax taxes everything above the 7,720.
What am I missing?
Thanks for any insight you may provide.
MJB
What you are seeing is the phase out of the SS income tax exemption. (aka the tax torpedo)
Once your “Combined Income*” exceeds $25k (Single filer), each $1 of other income results in $0.50 of SS no longer being tax-free. Or $1 of LTCG results in $0.50 of taxable income or $0.05 in tax, in your case.
* Combined income = All other income + 1/2 of Social Security income
Fascinating how much tax can be avoided in the states, particularly on qualified dividends and long-term capital gains. Really interesting article. Thank you!
Hi Jeremy,
Q1- Is Capital Gain Harvesting buy back method has to be done within the same year? or can it be done before tax deadline?
Q2-Tax Gain Harvesting Template, with a step-by-step example was use Fidelity site. I don’t see “Trade type” selection “Margin” when I use Vanguard account, after I submitted, it shows as “Cash”, would it still count as Unrealized long-term capital gains? please help explain more detail as I try to do this in the last minute, thanks.
A1 – you have to sell by Dec 31. Technically you could choose to never repurchase.
A2 – doesn’t matter if the trade is considered cash or margin – you just need a realized long-term capital gain
continue for Q1-If need for Capital Gain Harvesting purpose, what will be the answer?
Can the repurchase be the next day for the same one?
thank you.
For tax purposes, there are no requirements on timing of a repurchase. All that matters is you have a realized capital gain.
With the stated goal of completing a gain harvest, ideally you would sell/buy in the same moment so the sell and purchase prices are identical. But you could repurchase tomorrow or next week or next year or in 20 years.
Could you add an example step by step how to sell/buy in the same moment with the same fund in your Long-term Capital Gain Harvesting Template? that would be very helpful, I am slow on this.
I sold in Vanguard, but it won’t allow me to buy right away, it ask for new money in settlement or have to wait for settlement fund clear after couple days.
No worries, after you do it this time you’ll be an expert :)
It isn’t possible to buy/sell in the same instant, that is just the ideal. When the funds settle in your Vanguard account you can repurchase. The important thing is you have a realized long-term capital gain before Dec 31.
I’m curious, how do you reconcile the moral aspects of this? If you could have 100% avoided taxes throughout your working career as well, would you have done so? If so, who do you think in society should cover the cost of infrastructure, schools, defense, etc. if not you? And if not, what is “enough” in taxes to feel like you’ve paid your fair share?
I should add- I’m not trying to simply outright challenge you, I’m genuinely curious, because I am struggling with this question as I navigate my own FI journey.
I don’t reconcile the moral aspects. Everybody should follow the law, and tax law is what it is.
The tax laws are dumb though, and I vote for politicians who would increase our tax obligation.
For more on this, see:
Something for Everybody
Besides the President, Who Pays No Taxes?
Thanks for the response- I will read the links.
Hi GCC,
Have a question about this regarding your example above. I apologize if you already covered this somewhere else.
Say you accidentally go over the 0% limit for LTCG and dividends. Is every dollar then taxed at the next bracket? Or only the dollars that went over the 0% limit, similar to wage brackets?
Thanks and either way a sweet deal!
similar to wage brackets, you only pay tax on the overage
Great info all around. Glad I stumbled onto this site. So I’m clear…
1) Earned income up to the standard deduction ($25,100 for married filed jointly in 2021) is tax free. The investment income portion ($80,800 for married-jointly filing in 2021)– is that in addition to the earned income (making a total of $105,900) or is the $80,800 limit inclusive (earned + investment income)?
2) Using the numbers above, if investment income were $90,800, would only $10,000 of it be subject to the 15% tax rate (amount greater than $80,800)?
3) For a working couple, let’s say they have $125,000 in earned income and $10,000 in investment income (LT capital gains)… would the capital gains tax on the $10,000 be $0 since it is under the $80,800 threshold?
I know I’m missing something here and suspect it has to do with reaching the correct total income level. Above which I don’t know if all investment income would be taxed at the 15% or 20% rate as defined by total income or just that portion greater than $80,800 (in 2021)?
1 – it’s inclusive
2/3 – all of the capital gains would be taxed at 15% as your earned income has filled the lower tax brackets.
If you take a stab at running your own business, is there anyway to shovel all of your income into a retirement account? That way you could draw from your investments tax free like you mentioned and lock in some gains.
Possibly – see our Solo 401(k) Contribution Calculator to experiment. Can contribute $50k+ with some restrictions
Dear Jeremy & Winnie, thanks a bunch for sharing your inspiring life.
We plan to sell our house in GA & retire next year. Then, spend 9 months out of the country slow traveling. 3 months of the year will be spent in the states -some with family in Arkansas. My question: we’d love to have an address in a state w/o income tax -FL or NH, however we’re not sure how to establish residency in a state where we’d likely just Airbnb for a month a year. Any thoughts? Thank you! Dave & Mike
So… most states consider you a resident until you formally establish residency elsewhere. The documentation for this is typically in the tax filing instructions for partial year or nonresidents.
Formally establishing residency means moving somewhere, renting/buying, registering to vote, getting a driver’s license, opening a bank account, etc… while doing the inverse in your former home state. Just having a mailing address isn’t sufficient.
Hello Jeremy,
Would love to connect on a call and pay you for advisory services:
I would like to invest at least $40,000 per year in Vanguard ETF’s (i.e. ASX 200). However, I need to set up the right structure considering tax before I drive down this path aggressively transferring at least $40,000 funds each year for the next 35 years.
Considering the following:
1. Citizen of USA and Australia but living in Australia
2. As I am already at the $180,000 AUD salary threshold in Australia, my marginal tax rate for any additional income is 45%! To minimise tax, should I set up a personal company for the Vanguard investments?
3. If so, should my personal company be in the USA (LLC, etc.) or in Australia (Pty Ltd, etc.) or elsewhere offshore (i.e. Caribbean, Dubai, etc.)?
4. Is investing in other foreign Vanguard ETF’s tax efficient or would domestically investing in the Vanguard ASX 200 be most tax efficient (considering franking credits) for me?
Or perhaps you have even better outside of the box thinking/solutions!!
Thanks in advance
I cannot help with this. Going down the offshore business path has real costs, probably not worth it unless you add another zero or two to your income and savings numbers.
I used your tax calculator using $55k in pension income, and the calculator thinks I can have another $50k in LTCG income before additional taxes kick in. The LTCG table says $80k. What am I missing from the scenario?
You are missing:
– the standard deduction
– your pension income uses some of the LTCG 0% tax space
This series has saved me & my spouse at least $45,000! Not necessarily any 1 suggestion in particular, but mostly just by knowing that there were tax optimization options, and starting my own research on what options were best suited for my tax situation. Thank you for sharing!