What if you could pay 0% tax for the first few years of early retirement?
You receive income, yet you don’t pay any taxes.
This is not a trick. This is just simple understanding of the tax code.
Let’s dive in.
Do I Have the Right Tool for 0% Tax?
First, to retire early and not pay taxes, you’ll need a taxable investment account.
Confused yet?
Well, the taxes that you pay in a taxable investment account are based on short-term or long-term capital gains. Sometimes, you don’t have a big enough gain for the IRS to tax you.
Short-term capital gains:
Pay regular marginal income tax rates
Includes non-qualified dividends and interest
Realized investment gains on positions you’ve held 365 days or less
Long-term capital gains:
Pay a special long-term capital gains tax rate (0%, 15%, or 20%)
Includes qualified dividends
Realized investment gains on positions you’ve held longer than 365 days
How Do I Pay 0% Tax?
Using the taxable investment account, you can achieve a 0% income tax, if you’re strategic.
If you were to stop working, meaning you have no earned income, you could sell investments in your taxable investment account to provide your early retirement income.
Important: you’ll be realizing long-term capital gains, not short-term capital gains.
For 0% income, you can receive a maximum of $44,625 (single) or $89,250 (married) and pay zero tax.
Well, it’s actually more when you factor in a standard or itemized deduction. That really means you could make about $58,000 if single and about $116,000 if married and qualify for this 0% tax.
What’s the Catch?
Many times, investors misunderstand the capital gains tax laws and how they “stack” with other income.
For example, if a married couple had $40,000 of earned income and $100,000 of long-term capital gains income, their total income is $140,000. The couple may falsely believe that since their $100,000 is less than the $116,000 threshold that I just shared that they’re in the clear.
However, here’s how it breaks down:
$140,000 - $29,200 (MFJ standard deduction) = $110,800
$110,800 - $89,250 (long-term gains 0% bracket limit) = $21,550
$21,550 x 15% (the next long-term gains bracket) = $3,232.50 capital gains tax
You’d also owe income tax on the earned income portion, but this example is to show how your capital gains rates are affected.
Long story short, it’s important to understand how other income, when put together with your capital gains, affects your overall taxes owed.
How Does This Fit Within My Financial Plan?
If you are able to save into a Roth IRA and/or Roth 401(k), this strategy of living off of only long-term capital gains in your 50s could limit your tax exposure before you reach age 59.5, when you would then be paying 0% tax on earnings from your Roth accounts.
(For those not certain, “Roth” accounts are retirement accounts designed to have you pay 0% tax when you take money out, usually after age 59.5.)
Though everyone’s situation is different and may require different solutions, many of my younger clients targeting early retirement will have some combination of a taxable investment account and a Roth account.
You do have one very important question to answer: what investments in the taxable investment account do I sell?
That means knowing:
When to sell what positions
How to rebalance without changing your desired tax structure for the year, and
How to make your taxable account not run out a couple years short of accessing your “regular” retirement funds
And that’s also where financial planners like myself go beyond just picking an ETF for you to park your money—we want to help that money last. That means helping you understand how to pay a low lifetime tax bill and keep more of your money.
Want to Get Started on Your Path to Tax-Free (or close to it) Early Retirement?
Hi, I’m Tyler Shamblin, CFP®.
I’m a financial planner serving clients in the Memphis area in-person and across the USA online.
If you want to learn more about me, click here.
If you want to learn more about my firm, click here.
If you want to join an exclusive email list with over 100 other people who also don’t want to retire when they’re so old that they can’t enjoy but just a few years of their hard-earned wealth…
…then click here. You’ll get a free Early Retirement Guide when you sign up!
Osaic Wealth Inc. does not offer tax advice.
Century Financial is an investment management and financial planning firm in Germantown, Tennessee. Do you have questions about your financial strategies?
We'd love to give you the answers you need...without you feeling like you're being sold something. Send us an email at info@centuryfinancialllc.com or call 901-752-0022.
Comments