How to Pay Zero Taxes in Retirement
TRANSCRIPT
[00:00:05] Hi, this is Antwone Harris with Platinum Bridge Wealth Strategies, and I'm going to talk to you today about some strategies that can help you reduce or even eliminate your income taxes in retirement.
[00:00:16] The first thing you need to be aware of is there's a difference in taxation between ordinary income and long-term capital gains.
[00:00:23] So, ordinary income will be money that you make from wages or from business income, a pension, even social security. Also, any money that's distributed from an IRA account or a 401K account is considered ordinary income.
[00:00:39] A long-term capital gain would come from if you sold some real estate that you've held for more than 12 months, or if you sold stock or a mutual fund or an ETF. That's where the long-term capital gains apply.
[00:00:52] There's a difference in taxation between the two, and if we're strategic, we can use strategies to help reduce or eliminate your taxes in retirement.
[00:01:02] Here's an example. If you do a distribution from your IRA account, it's taxed as ordinary income. So, the first up to $11,000 is 10%, up to 44,725 is 12%, and so forth. However, we can book up to $44,625 if you're an individual; in long-term capital gains and pay 0% in taxes.
[00:01:25] Now, if you're married filing jointly, you can book up to $89,250 and pay 0% in long-term capital gains taxes. How we coordinate this could have a huge impact on your taxes.
[00:01:38] So, say for example, you're married filing jointly and you need some money to live on, up to $89,250, we could book in long term capital gains and you pay 0% in taxes. However, if you also pull money out of the IRA account, it's considered ordinary income and it will crowd out this opportunity to pay 0% long-term capital gains taxes.
[00:02:02] Let's show an example where you pull $50,000 out of your IRA account. That's going to be considered ordinary income and that is counted first. So, you had $89,000 if you're married filing jointly. You had $89,250 and this 0% long-term capital gains bucket, but you eliminated $50,000 of that because you pulled money out of the IRA account.
[00:02:28] The key point here is as we pull money out of the IRA account, as we book ordinary income, regardless of the source, it's going to crowd out the 0% in long-term capital gains.
[00:02:39] Now in this example, we still have an opportunity there. The total threshold is $89,250. We pulled $50,000 out of the IRA account.
[00:02:47] The next $39,250 is still going to be subject to the 0% long-term capital gain. The key point for you to remember without getting into the minutiae is that there's an opportunity to reduce your taxes if you're strategic about how you handle your distributions.
[00:03:03] Let's look at a hypothetical situation where we have a married couple that needs $150,000 to live on in retirement for the year. There's different ways we can do it. We can pull $150,000 out in long-term capital gains. We can do in scenario two, $150,000 in IRA distributions, or we can do a combination of the two.
[00:03:25] If we do $150,000 in long-term capital gains, you're going to pay federal taxes of $4,733, in this particular example.
[00:03:35] If we pull it all out of the IRA account, you'll pay $17,191.
[00:03:40] And if we do a combination, it's $9,789.
[00:03:44] So, let's think about these different options here. We pull $150,000 out of the IRA account. That's an 11.5% effective tax rate. You pay taxes at $17,191.
[00:03:56] If we did it all in long-term capital gains, that's 3.2%; $4,733
[00:04:02] And if we do a combination, it's six and a half percent.
[00:04:06] The key thing to think about is when you pull money out of the IRA account, in effect, you're taxed twice.
[00:04:14] You're taxed on the actual ordinary income, right? But you also have now changed the long-term capital gains that you may have from 0% up to this 15%. In effect, you've changed how you're taxed on all the money that you've raised to fund your retirement. It may make sense for us to try to eliminate or mitigate taxes in a particular tax year.
[00:04:42] You may have some other things going on where we need to reduce taxes in that year. Or we may want to be strategic and start to think about how we're going to plan out your tax liability in the future using software and using projections for your income that we expect down the line.
[00:05:00] One thing to remember, claiming long-term capital gains will not cause your ordinary income to be taxed at a higher rate. In this example, if we can pull up to $44,725, if you're an individual, and be in the 12% ordinary income tax bracket. Now, even if we then take a million dollars in long-term capital gains, it will not thrust you into the highest tax brackets. You're still going to have your ordinary income tax at this 12%. That's actually good news. But what it will do is it will crowd you out of this 0% tax treatment for the long-term capital gains, and you're going to be subject to 15% plus with the Affordable Care Act and the other thresholds to pay on for your long-term capital gains taxes.
[00:05:50] It's very important for you to diversify your pools of income. As you're planning for retirement, or even if you're already in retirement, if all of your money is in a 401K account or an IRA account, every dollar that we pull out, you're going to pay ordinary income taxes on, and our hands are tied. We really don't have any planning opportunities.
[00:06:11] If we can diversify those pools, have some money in a Roth account where that money comes out tax free. Have some money in non-retirement accounts where we could utilize the opportunity for the 0% in long-term capital gains, that's a huge advantage for you when we're starting to try to mitigate some of your taxes in retirement.
[00:06:30] We also need to plan for your tax situation now and your tax situation in the future. Once your social security hits, and once you start taking those required distributions at age 72 on- from the IRA accounts and the 401k accounts, you're going to have a lot of ordinary income come into play that's going to kind of tie our hands and not have as many planning opportunities.
[00:06:53] So, before you claim your social security, before those required distributions hit at age 72, we need to be strategic around how we can manage your tax situation now and in the future.
[00:07:06] There's a lot of moving parts here, and I try to keep this as simple as possible, but there are many other variables that need to be considered before you try to implement a strategy like this. Please consult with your tax professional or your financial advisor.
[00:07:19] If you have any questions, don't hesitate to reach out to me at my email below. This is Antwone Harris with Platinum Bridge Wealth Strategies, and I'll talk to you.