Our topic on this episode of the Ready for Retirement podcast is about understanding if capital gains can cause you to move into a higher tax bracket.
Questions to ask ourselves: Are there different tax brackets for Ordinary Income v. Capital Gains? When does it make most sense to realize Capital Gains? How should I be approaching tax planning as I near retirement? How should I be approaching tax planning if I’m already retired? How can I minimize my tax bill with proper tax planning, both for today and the future?
Are you ready to start focusing on the things that truly matter when it comes to your financial future?
Reference Sheet: 2021 Important Numbers Tax Sheet
Key Points
- If I were to invest in a stock and choose to sell and realize a gain, does that impact my ordinary income?
- No – Capital Gains are taxed separately from Ordinary Income.
- It will not push you into a higher tax bracket (assuming Long-Term Capital Gains).
- Note: A Short-Term Capital Gain doesn’t qualify for preferential tax treatment and is taxed as Ordinary Income.
- However, when you realize a Capital Gain, it impacts your adjusted gross income.
- No – Capital Gains are taxed separately from Ordinary Income.
- What’s included in my Adjusted Gross Income?
- Interest Income, Salary, Capital Gains, etc.
- AGI determines your eligibility for IRAs/Roth IRAs, etc.
- Once above certain thresholds, you may no longer be eligible for certain accounts.
- AGI impacts your ability to itemize certain deductions.
- AGI impacts your Net Investment Income Tax.
- AGI impacts Medicare Surcharges.
- Do Capital Gains push me into a higher tax bracket?
- Capital Gains have preferential tax treatment depending on when you realize gains.
- You are taxed at 0%, 15%, or 20% depending on your income level.
- Capital Gains have preferential tax treatment depending on when you realize gains.
- Ordinary Income Example
- Let’s assume you’re in the 24% Marginal Tax Bracket.
- No amount of Long-Term Capital Gains will push you into a higher tax bracket.
- A Short-Term Capital Gain doesn’t qualify for preferential tax treatment and is taxed as Ordinary Income.
- Let’s assume you’re in the 24% Marginal Tax Bracket.
- Capital Gains Taxes
- If your taxable income is $88,800 or less and you file MFJ, your Capital Gains Tax Rate is 0%.
- If your taxable income is between $88,800 – $501,600, your Capital Gains Tax Rate is 15%.
- If your taxable income is over $501,600, your Capital Gains Tax Rate is 20%.
- All of these percentages are at the Federal levels.
- Taxable Income
- Adjusted Gross Income – Deductions
- Example: Assume you’re retired and your $80,000 of income is from an IRA and your deductions are $30,000.
- In this case, taxable income is $50,000.
- Remember, you pay 0% in Capital Gains taxes up to $88,800 if you file MFJ, which means you may realize up to $38,800 in gains and pay 0% in taxes.
- What is “Gain-Harvesting”?
- Tax gain-harvesting includes intentionally realizing gains to pay nothing/very little in taxes.
- Roth Conversions
- To avoid being pushed into a higher tax bracket when RMDs begin (Required Minimum Distributions are required), converting funds from your IRA to your Roth IRA may be a useful tax planning tool.
- Withdrawing funds from your stock portfolio are taxed at 15% assuming LTCG rates, and all contributions are withdrawn tax-free (return of principal).
- Important Considerations
- If you’re working today with high income, realizing Capital Gains/Ordinary Income may not make sense.
- If you’re retired and before age 72, you may likely have the opportunity to manipulate your income to lower your tax bill today and in the future.
- You can keep tax brackets low and realize gains at 0%/very little depending on your income level.
- When income is low or if you’re temporarily unemployed, it may make sense to realize gains (outside of any IRAs/401(k)s)
- Overview
- Capital Gains do not impact your Ordinary Income (assuming Long-Term Capital Gains).
- Understand when it makes sense to realize gains and how to implement tax-strategies to minimize taxes and create more income today and for the future.
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