Retirees: The Tax Rule That Decides Whether Your Gains Are 0%, 15% or 20%
As if retirement planning — whether looking ahead or actively navigating retirement after leaving your nine-to-five behind — wasn’t confusing enough, your investment portfolio can present new and often unforeseen challenges.
One tax rule which many retirees might not be aware of pertains to long-term capital gains (LTCGs), as opposed to short-term capital gains (on investments held for 12 months or less), the latter of which is simply taxed as ordinary income within your regular bracket rate.
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As FigureCal explained, LTCGs are instead offered preferential rates of 0%, 15% or 20% depending on where gains might fall.
The first thing to keep in mind: Ordinary income fills the lower income brackets first, with LTCG income being applied on top and filling the following brackets. Ordinary income includes your wages, 1099 income, short-term investment gains, interest, and distributions or withdrawals from taxable retirement accounts, typically IRA or 401(k).
Rate | Single Filers | Married Filing Jointly |
0% | $0 — $48,350 | $0 — $96,700 |
15% | $48,351 — $533,400 | $96,701 — $600,050 |
20% | Above $533,400 | Above $600,050 |
Also, high-earning retirees should also be aware of the Net Investment Income Tax (NIIT), which applies a 3.8% federal surtax on net investment income. The thresholds for the NIIT currently rest at $200,000 for single filers, and $250,000 for those married filing jointly.
Income Valleys Can Reduce Tax Bills — But Not Everyone Benefits
The next thing to consider is whether or not you actually have an opportunity here, a silver lining in the form of what’s termed an income valley.
According to Fidelity, retirees can avail of an income valley in the years following retirement — provided they are no longer collecting their usual wages, and that Social Security benefits, any pension income, and any retirement-tied withdrawals are either absent or not yet ramped up.
In cases like these, it may be wise to actually make withdrawals from investment accounts in order to fill in gaps in the 0% bracket, essentially scoring these long-term capital gains without having to pay federal taxes on them.
However, once age 70 rolls around — and there’s no longer any benefit to delaying the disbursal of Social Security benefits any longer — this income valley necessarily shrinks. Further, when any required minimum distributions (RMDs) from relevant investment accounts kick in at age 73, the likelihood of retirees being able to take advantage of these so-called income valleys shrinks to near-nothing.
State-Level Taxes on LTCG Income Can Wreck Your Plans
There’s also the issue of realized LTCG income actually increasing any retiree’s adjusted gross income (AGI) — this could impact how much of one’s Social Security benefits are considered to be taxable. Simply put: You may find yourself reaping tax-free gains on investments, but your AGI could still increase to the level where more of your benefits are included in taxable income.
Lastly, don’t forget that state-level taxation on LTCG income differs from the federal thresholds. Examples include Oregon, New York, and California offering no preferential treatment of such income (with California charging capital gains as ordinary income up to 13.3%). Meanwhile, states with no income tax — including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming — exempt LTCG from taxation.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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