0% Capital Gains Tax In Retirement? Here’s How

 

Believe it or not, it’s possible to have 0% capital gains tax rates in retirement – or even before. Tax changes from the Jobs and Growth Tax Relief Reconciliation Act of 2003, which, strangely, were actually implemented in 2008, allowed for zero capital gains taxes for people with relatively low taxable income. Today, we’ll go over how you could potentially take advantage of these rates in retirement.

Who Qualifies For 0% Capital Gains Tax Rates?

First and foremost, it’s important to know that only long-term capital gains are eligible for 0% tax rates. There are no opportunities to pay 0% for short-term capital gains, unfortunately. So, this would only apply to investments you’ve owned for over a year.

In order to qualify for 0% long-term capital gains tax rates, your AGI (adjustable gross income) must be lower than $40,400 for anyone filing as single and $80,800 for those who are married filing jointly. These are the limits for 2021 and will index in future years, so consult with your CPA about your specific situation. While these income limits are fairly low for anyone who is concerned with a large capital gains tax bill, there are certain scenarios where it could be applied in early retirement.

When Is This An Appropriate Strategy?

There are two conditions that would potentially make this a great strategy for retirees. First, of course, you would need to own an appreciated asset that is subject to capital gains taxes. A great example here would be a large amount of employer stock purchased over the years as part of an Employee Stock Purchase Plan (ESPP). For many clients I’ve helped in the past, diversifying out of their company stock while minimizing capital gains taxes can be a challenge.

The second condition needed to make this strategy work would be a current or future tax year with low income. For many new retirees, having no more paychecks translates into lower taxes. There’s often a window between retirement and age 72 where a retiree’s income may be low enough to take advantage of 0% long-term capital gains tax rates. This can create an opportunity to be strategic when planning for taxes in retirement.

As a reminder, age 72 is when required distributions from retirement accounts begin. These distributions are taxable and could easily move you outside of the AGI limits for zero capital gains taxes. Social Security retirement income also adds to your AGI, so it may make sense to weigh the decision on timing your Social Security in the context of this strategy as well.

Finally, there are also other scenarios where you could potentially take advantage of 0% capital gains tax rates before you retire. Years where you are temporarily unemployed or low-income years for those who work on variable compensation are a couple of examples.

How Does It Work?

Let’s suppose that you consult with your CPA and determine that your 2021 AGI will end up being $60,000 (as married filing jointly). If so, you have the ability to add another $20,800 in long-term capital gains as income with no additional tax liability.

Since capital gains are included in your AGI number, you can reach the limit of these preferred tax rates rather quickly. In fact, making this strategy work could potentially be a little tricky, so please consult with your CPA during this process. You don’t want to go $1 past the AGI limits here or you could find yourself paying 15% instead of 0%.

Another thing to consider would be how the sale of this asset impacts your overall portfolio. Unlike tax loss harvesting, there’s no wash-sale rule that would prevent you from repurchasing the same asset. That’s right – if you still wanted to own the stock (or ETF or mutual fund) as part of your portfolio, you could harvest the gain, pay 0% in capital gains taxes for realizing those gains, and immediately repurchase that same stock.

However, for most people, large potential capital gains are most often tied to concentrated stock positions – or else they would have been sold and diversified long ago.

Creating A Retirement Tax Plan

While taking advantage of 0% capital gains tax rates in retirement is a smart strategic move, it should fit into your overall retirement tax plan. It should only be used if it’s right for you. While retirement years with low taxable income may bring the opportunity to pay zero long-term capital gains taxes, they can also be used to make strategic partial Roth IRA conversions. The right strategy for you will depend on many variables.

If you need help creating a retirement tax plan that takes advantage of 0% capital gains tax rates, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.

As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.


The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
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