By Dr. Jim Dahle, WCI Founder
I spend most of my time writing about the financial problems of top earners and the wealthy. Due to the highly progressive nature of our federal income tax system (where nearly half of “taxpayers” actually pay no federal income tax at all), some of the “right answers” for top earners are not right for those in lower tax brackets. The 0% long-term capital gains (LTCG) bracket provides numerous examples of this phenomenon.
The 0% bracket for long-term capital gains
Let’s say you have $10,000 in LTCGs. At what rate is it taxed? That depends on how much other income you have. If you have no other income, those LTCGs are tax-free. You’re in the 0% LTCG tax bracket. What is that tax bracket? For single people, it ranges from $0 to $47,026 in 2024, and for those filing jointly (MFJ), it rises to $94,051. But it’s actually higher because of the $14,600 standard deduction ($29,200 MFJ). So a married couple with no other income could earn $94,051 + $29,200 = $123,251 in LTCGs and pay $0 federal income tax.
That’s actually quite a lot of income considering the average American household makes just over half that (about $75,000). Even if you have other income, you can have all of your LTCGs in the 0% bracket. Imagine a married couple with $40,000 in Social Security income, a $20,000 pension, and $25,000 in required minimum distributions (RMDs). You can still take up to $38,251 in LTCGs at 0%. The media often talks about how generous the LTCG and qualified dividend tax brackets are for the super-rich, but it’s pretty clear to me that they’re pretty generous for everyone, and probably even more generous for low-income earners than top earners.
What impact does this have on financial planning?
Earn tax profits
If you are only temporarily in the 0% LTCG bracket, you may want to take advantage of tax gain harvesting. Tax gain harvesting actually allows you to make taxable gains (that you don’t have to pay taxes on) that you don’t have to make, just to increase your investment base. In theory, this will reduce future LTCG taxes when you are in a higher LTCG bracket later on. This is very different from the usual advice we give to high earners to harvest their tax losses.
Plans for withdrawing retirement savings
The general retirement rule of thumb for high earners is to spend from your taxable account first before accessing your retirement accounts—and then mix your tax-free and tax-deferred account withdrawals as needed to control your tax rate. This approach minimizes taxes, promotes growth, and maximizes wealth protection. For someone in the 0% LTCG and qualified dividend bracket, however, a taxable account behaves almost exactly like a Roth IRA. It is not taxed as it grows (as long as it only pays qualified dividends), and no tax is due when you “withdraw” from it. Rather than spending from taxable accounts first, the correct approach is to “mix” taxable and tax-deferred withdrawals at an acceptable overall tax rate.
More information here:
How do you reach the zero tax bracket in retirement?
How tax diversification can help you reduce taxes now AND in retirement
Roth Conversions
Roth conversions are generally a good move for early retirees. Essentially, you’re moving taxable assets into tax-sheltered accounts. But if you live in the 0% LTCG bracket (and expect to stay there), the only reason to move taxable assets into tax-sheltered accounts is to facilitate estate planning and asset protection. The taxable account already behaves like a Roth IRA, at least in that it’s invested in tax-efficient, broadly diversified index funds. You’ll likely make fewer Roth conversions — if any at all.
Decide whether to use retirement accounts at all
If you’re in the 0% LTCG bracket and expect to stay there, contributing to retirement accounts won’t do nearly as much good. Yes, they’ll allow you to invest in bonds, REITs, and other tax-inefficient assets in a more tax-efficient way and improve your asset protection, but they won’t do nearly as much to reduce taxes. The “always fully fund your retirement accounts,” “don’t miss out on that Roth IRA,” and “invest in retirement accounts first” dogma is starting to crumble.
More information here:
Comparison of 14 types of retirement accounts
Some top earners end up in the 0% LTCG class
Don’t be ridiculous and assume that this post doesn’t and never will apply to you. There are plenty of situations where a very wealthy retiree will spend their time in the 0% LTCG bracket. Let’s say you want to spend $200,000 per year in retirement. You can live a pretty nice life on $200,000 per year if none of it has to go to retirement savings, college savings, payroll taxes, disability/life insurance premiums, or commuting costs — and only a small portion of it has to go to income taxes. Spending $200,000 means a nest egg of $4 to $5 million, depending on the value of Social Security or pensions. But imagine a married couple spending $200,000 if it comes out of this breakdown:
- 40,000 USD Social Security
- $40,000 from a traditional IRA
- $40,000 from Roth IRA
- $80,000 from a taxable account, 75% of which is basis
Total: $200,000 disposable “income” and $100,000 taxable income. Actual tax liability is $4,912.
What LTCG tax bracket is this couple in? That’s right. It’s 0%. In fact, they could spend a lot more from this taxable account before entering the 15% LTCG tax bracket.
It is important to know about and take advantage of the 0% LTCG bracket. It is actually quite generous and applies to the majority of Americans and even many retired WCIs.
What do you think? When have you ever been in the 0% LTCG category or do you expect to ever be? How will you take advantage of this fact? Leave a comment below!
