Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

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investorpeter
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Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sat Sep 30, 2017 8:52 pm

I'm getting to the point of thinking about the best time to retire early. And while there are many other factors that go into the decision, I can't help but try to think about the most tax-efficient strategy, so I thought I would just think this out in writing and see if others have comments or are thinking along the same lines for their own situation.

Let's say that I have significant long-term capital gains in a taxable account. Though the situation is more complicated, let's say for simplicity, that I will start collecting a $40,000 pension and $35,000 in social security at age 67, for total of $75,000 income. The long-term capital gains tax is 0% up to the 15% federal income tax bracket, which happens to top out at $75,000 today for married, filing jointly. Above the 15% income tax bracket, the long-term capital gains tax rate jumps to 15%, so there is a strong incentive to keep my income below $75,000 until I have realized all of my long-term capital gains. Interestingly, $75,000 also happens to be my annual expenditure. Since I will already be at the $75,000 income limit at age 67 due to pensions and social security, I should retire before age 67 and live off $75,000 capital gains per year in order to maximize the 0% capital gains rate. So my ideal "early retirement age" should be ((67 - (long-term capital gains/$75,000)). So if I have $750,000 in long-term capital gains, I should retire at age 57 at the latest. If I have $1.5 million in long-term capital gains, I should retire at 47 at the latest.

Obviously, this requires assumptions about tax brackets and rates in the future, but assuming things do not change much, does this sound reasonable for a tax-strategy for early retirement? I know there are other benchmarks for early retirement, such as 25-40x annual spending, 2-4% withdrawal rates, and others, but I'm trying to work backwards based on the tax considerations.

livesoft
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by livesoft » Sat Sep 30, 2017 9:04 pm

If you sell shares, then some of that will be return of capital and not show up on your tax return. Furthemore, the $75K is taxable income and not total income. Your exemptions and deductions will be deducted beforehand.

So you can probably sell more than $100K of current value shares and end up pay $0 in taxes. You might as well practice tax-gain harvesting and spend only $75K.

And if you don't retire early, then you may end up with less money to spend after taxes.

See also: viewtopic.php?t=87471 where towards the end some posters were upset that someone with twice the income would have less for expenses after taxes.
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investorpeter
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sat Sep 30, 2017 9:33 pm

Yes, exactly. That was quite an eye-opening realization for me. Makes it seem like a no-brainer to stop working enough years before a pension starts to be able to harvest capital gains.

And I see your point about the exemptions and deductions reducing my taxable income thereby providing some wiggle room. I think in the first years of going this I would want a decent buffer to keep me in the 0% capital gains bracket, just in case there was some unexpected bolus of income such as a special dividend on a stock I owned. But after a couple of years, it might be fun to push the limit. I think the key is to keep annual spending within the 0% tax bracket or have sufficient savings to make up the difference.

I wonder if others in early retirement are actually doing this. Would love to hear

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by KlangFool » Sat Sep 30, 2017 9:41 pm

https://www.bogleheads.org/wiki/Tax_gain_harvesting

OP,

Why do you need to retire before you do this? Depending on your current marginal tax rate, you may do some tax gain harvesting now.

KlangFool

RedClay
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by RedClay » Sat Sep 30, 2017 9:47 pm

Several points:

(1) Make sure that you really understand how long-term capital gains are taxed. I just explored this recently and it's a bit tricky. Michael Kitces has an excellent explanation at https://www.kitces.com/blog/understandi ... -in-basis/ that is very relevant to your capital gains harvesting idea. The basic idea is that long-term capital gains are "stacked" on top of ordinary income, and taxation of long-term capital gains is itself progressive. For example, say you have taxable income of $80,000 for 2017 - of which $70k is ordinary income and $10k is long-term capital gains. The MFJ 15% taxable income bracket ends at $75,900. Therefore, you would pay ordinary tax rates on the $70k, a 0% rate on the first $5,900 of LT capital gains, and a 15% rate on the last $4,100 of LT capital gains.

(2) If you have any money in tax-deferred accounts, you could also consider doing Roth conversions in your retirement years. Since the conversions would count as ordinary income, this would reduce the space you have for 0% long-term capital gains. If you have $750k in taxable LT capital gains at retirement, you probably also have sizeable tax-deferred accounts. You might want to give preference to the Roth conversions, because you can avoid higher ordinary income tax rates later in retirement (and also reduce your RMDs).

(3) Depending on your circumstances, you may want to avoid increasing your AGI during early retirement. Many deductions and credits are based on your AGI, which would be higher if you are pursuing Roth conversions or capital-gain harvesting. Also, a big factor is healthcare. Some early retirees keep their AGI low in order to qualify for the Obamacare health insurance premium subsidies.

I hope this helps!

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by livesoft » Sat Sep 30, 2017 9:51 pm

investorpeter wrote:
Sat Sep 30, 2017 9:33 pm
I wonder if others in early retirement are actually doing this. Would love to hear
I don't think the goal is to pay $0 in taxes, but just to pay a low amount of taxes.

You might be surprised that with your $40K pension plus $35K social security that you probably wouldn't pay any Federal income tax anyways. Have you run the numbers?
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sat Sep 30, 2017 10:12 pm

KlangFool wrote:
Sat Sep 30, 2017 9:41 pm
https://www.bogleheads.org/wiki/Tax_gain_harvesting

OP,

Why do you need to retire before you do this? Depending on your current marginal tax rate, you may do some tax gain harvesting now.

KlangFool
I would pay 20% capital gains if I sold today.

investorpeter
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sat Sep 30, 2017 10:23 pm

RedClay wrote:
Sat Sep 30, 2017 9:47 pm
Several points:

(1) Make sure that you really understand how long-term capital gains are taxed. I just explored this recently and it's a bit tricky. Michael Kitces has an excellent explanation at https://www.kitces.com/blog/understandi ... -in-basis/ that is very relevant to your capital gains harvesting idea. The basic idea is that long-term capital gains are "stacked" on top of ordinary income, and taxation of long-term capital gains is itself progressive. For example, say you have taxable income of $80,000 for 2017 - of which $70k is ordinary income and $10k is long-term capital gains. The MFJ 15% taxable income bracket ends at $75,900. Therefore, you would pay ordinary tax rates on the $70k, a 0% rate on the first $5,900 of LT capital gains, and a 15% rate on the last $4,100 of LT capital gains.

(2) If you have any money in tax-deferred accounts, you could also consider doing Roth conversions in your retirement years. Since the conversions would count as ordinary income, this would reduce the space you have for 0% long-term capital gains. If you have $750k in taxable LT capital gains at retirement, you probably also have sizeable tax-deferred accounts. You might want to give preference to the Roth conversions, because you can avoid higher ordinary income tax rates later in retirement (and also reduce your RMDs).

(3) Depending on your circumstances, you may want to avoid increasing your AGI during early retirement. Many deductions and credits are based on your AGI, which would be higher if you are pursuing Roth conversions or capital-gain harvesting. Also, a big factor is healthcare. Some early retirees keep their AGI low in order to qualify for the Obamacare health insurance premium subsidies.

I hope this helps!
Thanks, that is helpful. I read Kitces article and I think I understand it. Basically capital gains are considered income that is stacked on top of your ordinary income, so you can't realize an unlimited amount of capital gain at the 0% rate. You can only realize enough to whatever takes your AGI up to the top of the 15% income tax bracket. That realization is what ties this into early retirement, because ordinary income should be as close to 0 as possible to maximize tax gain harvesting, and it will take several years (maybe a decade) to do that. The majority of my investments are in taxable accounts so I have not considered Roth conversion of retirement accounts aside from the annual backdoor roth conversion of a trad ira to roth ira.

Yea, healthcare is the biggest question of all.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by RedClay » Sat Sep 30, 2017 10:28 pm

investorpeter wrote:
Sat Sep 30, 2017 10:12 pm
KlangFool wrote:
Sat Sep 30, 2017 9:41 pm
https://www.bogleheads.org/wiki/Tax_gain_harvesting

OP,

Why do you need to retire before you do this? Depending on your current marginal tax rate, you may do some tax gain harvesting now.

KlangFool
I would pay 20% capital gains if I sold today.
So that means you're in the top tax bracket right now. Consider tax-loss harvesting now (https://www.bogleheads.org/wiki/Tax_loss_harvesting). It would lower your basis on some of your investments and you get up to the $3,000 tax deduction. Then later on in retirement you could tax-gain harvest.

investorpeter
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sat Sep 30, 2017 10:34 pm

RedClay wrote:
Sat Sep 30, 2017 10:28 pm
investorpeter wrote:
Sat Sep 30, 2017 10:12 pm
KlangFool wrote:
Sat Sep 30, 2017 9:41 pm
https://www.bogleheads.org/wiki/Tax_gain_harvesting

OP,

Why do you need to retire before you do this? Depending on your current marginal tax rate, you may do some tax gain harvesting now.

KlangFool
I would pay 20% capital gains if I sold today.
So that means you're in the top tax bracket right now. Consider tax-loss harvesting now (https://www.bogleheads.org/wiki/Tax_loss_harvesting). It would lower your basis on some of your investments and you get up to the $3,000 tax deduction. Then later on in retirement you could tax-gain harvest.
I do tax loss harvesting pretty much whenever I can. It dulls the pain of taking a capital loss, but not entirely. :annoyed

RedClay
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by RedClay » Sat Sep 30, 2017 10:37 pm

investorpeter wrote:
Sat Sep 30, 2017 10:23 pm
Yea, healthcare is the biggest question of all.
Harry Sit at The Finance Buff blog has an old article about the Obamacare ACA Premium Subsidy Cliff - https://thefinancebuff.com/stay-under-o ... cliff.html. The article is from 2013, but I don't think any of the relevant laws have changed. It's an interesting strategy to get affordable health insurance for early retirees. But going this route would interfere with your capital gains harvesting strategy because you would have to keep AGI, or technically MAGI, low to avoid the premium subsidy cliff.

investorpeter
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sat Sep 30, 2017 11:12 pm

RedClay wrote:
Sat Sep 30, 2017 10:37 pm
investorpeter wrote:
Sat Sep 30, 2017 10:23 pm
Yea, healthcare is the biggest question of all.
Harry Sit at The Finance Buff blog has an old article about the Obamacare ACA Premium Subsidy Cliff - https://thefinancebuff.com/stay-under-o ... cliff.html. The article is from 2013, but I don't think any of the relevant laws have changed. It's an interesting strategy to get affordable health insurance for early retirees. But going this route would interfere with your capital gains harvesting strategy because you would have to keep AGI, or technically MAGI, low to avoid the premium subsidy cliff.
Interesting that the ACA subsidy cliff of 4x poverty level is also around $70,000, so it's definitely within reach of typical expenses. At 4x FPL the ACA subsidy is about $4000 and the savings on capital gains would be about $12,000 (15% of $75000), so the annual financial benefit of retiring early is $16,000. Its helpful to be able to put a number on it. Another way of looking at it, is that this is basically my financial penalty for NOT retiring early. I think the focus on early retirement discussions is usually on margin of safety which increases by delaying retirement, but it is interesting to consider there may be a financial penalty to waiting to retire. But the long term viability of the ACA is really the big question for anyone considering retiring before medicare age.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by FiveK » Sun Oct 01, 2017 12:37 am

livesoft wrote:
Sat Sep 30, 2017 9:51 pm
You might be surprised that with your $40K pension plus $35K social security that you probably wouldn't pay any Federal income tax anyways. Have you run the numbers?
MFJ both 67 with no income other than above, and standard deduction, would pay ~$4200 federal income tax, based on this tax calculator.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by #Cruncher » Sun Oct 01, 2017 2:18 am

RedClay wrote:
Sat Sep 30, 2017 9:47 pm
(1) Make sure that you really understand how long-term capital gains are taxed. I just explored this recently and it's a bit tricky.
It's even trickier when Social Security is considered. With the $40,000 pension and $35,000 SS benefit assumed in the original post, one can have $29,450 of Long Term Capital Gains (LTCG) before any are directly taxed. [1] However, even though they aren't themselves taxed, the first $14,441 of LTCG results in $1,841 of additional tax because they make $12,275 more of SS taxable. [2] The next $15,009 of LTCG results in no additional tax since the maximum 85% of SS has already been taxed. Any LTCG beyond that is directly taxed at 15%. This is shown in the following table: [3]

Code: Select all

Social Security 50% threshhold    32,000   ----------------------->
Social Security 85% threshhold    44,000   ----------------------->
Ord Income Tax Bracket 15%        18,650   ----------------------->
Ord Income Tax Bracket 25%        75,900   ----------------------->

Non-SS Ordinary Income            40,000   40,000   40,000   40,000
Social Security Benefit           35,000   35,000   35,000   35,000
LTCG & QDI                           -     14,441   29,450   30,450  <==
SS Relevant Income                57,500   71,941   86,950   87,950
50% SS taxable                     6,000    6,000    6,000    6,000
85% SS taxable                    11,475   23,750   23,750   23,750
Total SS taxable                  17,475   29,750   29,750   29,750
Adjusted gross income             57,475   84,191   99,200  100,200

Code: Select all

Deductions plus Exemptions        23,300   23,300   23,300   23,300
Taxable Income                    34,175   60,891   75,900   76,900
LTCG & QDI Taxable                   -     14,441   29,450   30,450
Ordinary Taxable                  34,175   46,450   46,450   46,450
Ordinary taxable @ 25%               -        -        -        -  
Ordinary taxable @ 15%            15,525   27,800   27,800   27,800
Ordinary taxable @ 10%            18,650   18,650   18,650   18,650
LTCG & QDI taxable @ 15%             -        -        -      1,000
LTCG & QDI taxable @ 0%              -     14,441   29,450   29,450

Code: Select all

Ordinary tax @ 25%                   -        -        -        -  
Ordinary tax @ 15%                 2,329    4,170    4,170    4,170
Ordinary tax @ 10%                 1,865    1,865    1,865    1,865
LTCG & QDI tax @ 15%                 -        -        -        150
Total tax                          4,194    6,035    6,035    6,185

Increased LTCG                         14,441   15,009    1,000
Increased taxable SS                   12,275        0        0 <==
Increased tax                           1,841        0      150 <==
Marginal SS taxable                    85.00%    0.00%    0.00%
Marginal tax rate                      12.75%    0.00%   15.00%
  1. For a 2017 joint return with both spouses age 65+ taking the standard deduction:

    Code: Select all

    12,700  standard joint deduction
     2,500  age 65+ extra deduction
     8,100  exemptions
     5,250  15% SS not taxed
       900  75,000 shy of 75,900 bracket
    ------
    29,450  LTCG before directly taxed
  2. See Taxation of SS benefits in the Wiki for an explanation of how SS is taxed.
  3. Calculated with the Compare sheet of my Marginal Tax Rates spreadsheet for an age 65+ couple taking the standard deduction on a 2017 joint return.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Sun Oct 01, 2017 4:36 am

FiveK wrote:
Sun Oct 01, 2017 12:37 am
livesoft wrote:
Sat Sep 30, 2017 9:51 pm
You might be surprised that with your $40K pension plus $35K social security that you probably wouldn't pay any Federal income tax anyways. Have you run the numbers?
MFJ both 67 with no income other than above, and standard deduction, would pay ~$4200 federal income tax, based on this tax calculator.
Yes, that's what my home-grown calculator says too. I get $4235 but that is using the 2015 brackets, etc., as I haven't updated it for the new amounts yet.

On the other hand, $35k social security + up to $46K LTCG gives a $0 tax bill.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by livesoft » Sun Oct 01, 2017 6:42 am

Thanks everyone for all the tax calculations. We were working on our 2016 taxes yesterday and found we get about $3500 in tax credits.

I'd expect that someone with a large taxable portfolio will get quite a lot of dividends even if they do not sell to realize capital gains. In my real world, some of those dividends are from international funds that create a foreign tax credit. My point is that the calculations in this thread do not show tax credits. (Also they don't show a -$3,000 capital loss.)

Then there are other deductions besides the standard deduction. For 2016, we bunched deductions. We have no mortgage interest deduction, but charity, property taxes, and sales taxes deductions get us about $22,000 in deductions.

The extra deductions and credits help reduce income taxes from what has been shown in this thread. So with higher AGI than $100K, our income tax was about $3300.

Finally, in #Cruncher's table, there is the line for "Increased LTCG" that shows the Marginal tax rate of 15.00%:

Code: Select all

Increased LTCG                         14,441   15,009    1,000
Increased taxable SS                   12,275        0        0 <==
Increased tax                           1,841        0      150 <==
Marginal SS taxable                    85.00%    0.00%    0.00%
Marginal tax rate                      12.75%    0.00%   15.00%
If a line is added "Increased Non-SS Ordinary Income", the Marginal tax rate might be 30%. That is, an increase in pension or non-qualified dividend income could have an apparent different Marginal tax rate.
Last edited by livesoft on Sun Oct 01, 2017 7:26 am, edited 1 time in total.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by MikeG62 » Sun Oct 01, 2017 7:22 am

RedClay wrote:
Sat Sep 30, 2017 9:47 pm
...If you have any money in tax-deferred accounts, you could also consider doing Roth conversions in your retirement years. Since the conversions would count as ordinary income, this would reduce the space you have for 0% long-term capital gains. If you have $750k in taxable LT capital gains at retirement, you probably also have sizeable tax-deferred accounts. You might want to give preference to the Roth conversions, because you can avoid higher ordinary income tax rates later in retirement (and also reduce your RMDs).
I have not really thought this through before, but the OP's post and your response got me wondering myself whether it is clearly better to do the Roth conversions in early retirement or to harvest LTCG's in taxable accounts at a zero tax rate (for those with very significant unrealized LTCG's in taxable accounts)?

Thinking out loud (and for simplicity considering only Federal income taxes), by tax gain harvesting LTCG's up to taxable income of ~$75K (after considering other taxable income, like interest and dividends, as well as tax deductions), the effective tax rate on those LTCG's would be zero. That seems like a good outcome.

The downside is that the amount of money in tax deferred accounts would be greater once RMD'S begin, such that a portion of those RMD's (especially once combined with SS) may be taxed at a 25% rate (current tax rules) - or 10% points higher than might well have been the case had a Roth conversion strategy been pursued in early retirement. So, you avoid a 15% tax rate on (some portion of) your realized LTCG's now in exchange for a 10% point higher rate on (some portion of) your RMD's in the future.

Of course, by Roth converting more of your tax deferred accounts in early retirement, you get tax free growth (current tax rules) on your Roth converted dollars and this benefit may more than swamp the apparent 5% point tax leverage computed in the preceding paragraph.

What do others think?

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by livesoft » Sun Oct 01, 2017 7:30 am

^I think Roth conversions all the way.

One can often avoid LTCG by other methods: Tax-loss harvesting, gifting, dying. Plus one can withdraw those Roth assets later and not increase taxes.

And don't forget that one has to pay tax on Roth conversions, so one will want to use money from a taxable account to do so. Whether that comes from dividends or capital gains is one's choice.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by TXJeff » Sun Oct 01, 2017 9:31 am

investorpeter wrote:
Sat Sep 30, 2017 8:52 pm
Let's say that I have significant long-term capital gains in a taxable account. Though the situation is more complicated, let's say for simplicity, that I will start collecting a $40,000 pension and $35,000 in social security at age 67, for total of $75,000 income. The long-term capital gains tax is 0% up to the 15% federal income tax bracket, which happens to top out at $75,000 today for married, filing jointly. Above the 15% income tax bracket, the long-term capital gains tax rate jumps to 15%, so there is a strong incentive to keep my income below $75,000 until I have realized all of my long-term capital gains. Interestingly, $75,000 also happens to be my annual expenditure. Since I will already be at the $75,000 income limit at age 67 due to pensions and social security, I should retire before age 67 and live off $75,000 capital gains per year in order to maximize the 0% capital gains rate. So my ideal "early retirement age" should be ((67 - (long-term capital gains/$75,000)). So if I have $750,000 in long-term capital gains, I should retire at age 57 at the latest. If I have $1.5 million in long-term capital gains, I should retire at 47 at the latest.
I'm wrestling with a related issue and wondering: what would be the impact of a bear market in the early years of this strategy?

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by livesoft » Sun Oct 01, 2017 9:40 am

TXJeff wrote:
Sun Oct 01, 2017 9:31 am
I'm wrestling with a related issue and wondering: what would be the impact of a bear market in the early years of this strategy?
In a bear market, equities will go down no matter what strategy one uses, so I'm not sure what the question is. I would be tax-loss harvesting and building up a huge carryover loss just like I did in 2000 and 2008-2009. I can say that all that tax-loss harvesting allows one to do more Roth conversions if one has tax-deferred money.

Another way to think about this is that if one has an asset allocation that they are maintaining and they are early retired, then it doesn't matter what the market does because one will be maintaining their asset allocation throughout bear markets and bull markets and sideways markets. And one doesn't even have to be retired early to maintain an asset allocation.

You may wish to read this series on SWR for early retirees (and everybody else, too): https://earlyretirementnow.com/2016/12/ ... t-1-intro/
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sun Oct 01, 2017 11:07 am

MikeG62 wrote:
Sun Oct 01, 2017 7:22 am
RedClay wrote:
Sat Sep 30, 2017 9:47 pm
...If you have any money in tax-deferred accounts, you could also consider doing Roth conversions in your retirement years. Since the conversions would count as ordinary income, this would reduce the space you have for 0% long-term capital gains. If you have $750k in taxable LT capital gains at retirement, you probably also have sizeable tax-deferred accounts. You might want to give preference to the Roth conversions, because you can avoid higher ordinary income tax rates later in retirement (and also reduce your RMDs).
I have not really thought this through before, but the OP's post and your response got me wondering myself whether it is clearly better to do the Roth conversions in early retirement or to harvest LTCG's in taxable accounts at a zero tax rate (for those with very significant unrealized LTCG's in taxable accounts)?

Thinking out loud (and for simplicity considering only Federal income taxes), by tax gain harvesting LTCG's up to taxable income of ~$75K (after considering other taxable income, like interest and dividends, as well as tax deductions), the effective tax rate on those LTCG's would be zero. That seems like a good outcome.

The downside is that the amount of money in tax deferred accounts would be greater once RMD'S begin, such that a portion of those RMD's (especially once combined with SS) may be taxed at a 25% rate (current tax rules) - or 10% points higher than might well have been the case had a Roth conversion strategy been pursued in early retirement. So, you avoid a 15% tax rate on (some portion of) your realized LTCG's now in exchange for a 10% point higher rate on (some portion of) your RMD's in the future.

Of course, by Roth converting more of your tax deferred accounts in early retirement, you get tax free growth (current tax rules) on your Roth converted dollars and this benefit may more than swamp the apparent 5% point tax leverage computed in the preceding paragraph.

What do others think?
OP here and I have to admit I'm not entirely understanding all the details being discussed by people who have obviously spent a lot more time thinking about and doing this. For me, it's all theoretical and I still have a lot to research, esp. about Roth Conversions. I had not even seriously considered the possibility of converting to Roth while having a 0% federal income tax rate (something like this). http://retireby40.org/pay-no-tax-roth-ira-conversion/

So why not do both and retire even earlier? Retire early enough to have low income years to convert tax deferred accounts to Roth, and to realize long term capital gains. So ideal early retirement age is 67 - (LTCG/$75000) - (Tax deferred assets/$75000). Assuming one has enough savings to live off of during the years of Roth conversions.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by Phil DeMuth » Sun Oct 01, 2017 11:29 am

You should do a long-term tax projection of your post-retirement life, taking into account the effect of rising RMDs from your qualified accounts. Only then can you estimate whether you are better off using your early retirement low income years for tax gain harvesting or Roth conversions.

If possible, I would consider postponing SS (and any other discretionary income) until 70 to buy more 5 more years of low income. I suspect that you would be better off living off capital gains at 0% tax than SS.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by MikeG62 » Sun Oct 01, 2017 12:28 pm

investorpeter wrote:
Sun Oct 01, 2017 11:07 am
...So why not do both and retire even earlier? Retire early enough to have low income years to convert tax deferred accounts to Roth, and to realize long term capital gains. So ideal early retirement age is 67 - (LTCG/$75000) - (Tax deferred assets/$75000). Assuming one has enough savings to live off of during the years of Roth conversions.
I think the problem is with a seven figure tax deferred account and seven figures in unrealized LTCG's in taxable accounts, the approach you outline won't be enough to make a huge dent in both accounts (if you want to keep taxable income under $75K). Keep in mind as well that anyone with seven figures in unrealized LTCG's is likely to have a fair amount of qualified dividends annually. So the amount you'd be able to take combined from both sources may be smaller than you think.

That is why I posed the question about whether the default of Roth conversions (which by the way I buy into) is the best strategy for someone with very large unrealized LTCG's. I suppose one other factor weighing in favor of the Roth conversion approach I did not consider this morning is the potential for a basis step up on death for the LTCG's. So it is possible that not all of the unrealized LTCG's will ultimately be realized later in retirement resulting in tax being paid if one pursues the Roth conversion approach instead of strategically harvesting LTCG's.

By the way, another factor not yet mentioned that will work against your ability to chip away at the account balances is the future growth in the value of the accounts. In other words, your LTCG's and tax deferred accounts are not static balances.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Sun Oct 01, 2017 9:59 pm

Tax strategy is VERY complicated, but I have made a very rough calculation suggesting that, for someone who is 57 today and married to someone of the same age, federal income taxes that would be paid on a $40K pension and $35K SS benefit (once that benefit starts), along with capital gains of about $100,000/year, would be about $10K to $15K a year initially. After SS begins, that increases to somewhere in the low to mid $20K's. These tax payments would be from a total lifetime cash flow of about $200K a year in constant dollars. This assumes 2% inflation, 7% annual portfolio asset gains, and 2% interest, and that both spouses are of average health and live to their median life expectancies.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by livesoft » Sun Oct 01, 2017 10:04 pm

technovelist wrote:
Sun Oct 01, 2017 9:59 pm
..., along with capital gains of about $100,000/year, ....
In order to realize $100,000 of capital gains per year, wouldn't one have to sell between $200,000 and $500,000 worth of shares thus getting return of capital of $100,000 to $400,000 which would all be tax-free?
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by FiveK » Sun Oct 01, 2017 10:08 pm

MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Sun Oct 01, 2017 10:47 pm

livesoft wrote:
Sun Oct 01, 2017 10:04 pm
technovelist wrote:
Sun Oct 01, 2017 9:59 pm
..., along with capital gains of about $100,000/year, ....
In order to realize $100,000 of capital gains per year, wouldn't one have to sell between $200,000 and $500,000 worth of shares thus getting return of capital of $100,000 to $400,000 which would all be tax-free?
Yes, return of capital is tax-free, but the amount of return of capital vs. capital gains depends on your (remaining) tax basis. In my simulation, I assumed a starting taxable account value of $2.5 million with a basis of $1 million (which I forgot to mention previously :oops:). In the first year the taxable sold amount is about $175K, with a basis of about $65K, producing a capital gain of about $100K. Obviously the numbers in future years depend on the actual gains in the account, which no one can know in advance.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Sun Oct 01, 2017 10:50 pm

FiveK wrote:
Sun Oct 01, 2017 10:08 pm
MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.
I get $16,619 after updating my calculator with the 2017 brackets, exemptions, and so on.
Last edited by technovelist on Sun Oct 01, 2017 11:24 pm, edited 1 time in total.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sun Oct 01, 2017 11:13 pm

Thanks everyone for the detailed calculations and advice. I will need a long weekend to digest all on this. But at least one thing is clear in my mind - that I need to at least consider Roth conversions before realizing LTCGs in early retirement. In my case, the LTCGs are about 2x the amount in tax deferred accounts, and the cost basis on the LTCGs is almost negligible due to holding some individual stocks for a very long time, so realizing the LTCGs in a tax-efficient manner has weighed most heavily on my mind, but I need to consider whether the Roth conversions of tax deferred accounts confer a greater tax advantage.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by CurlyDave » Sun Oct 01, 2017 11:28 pm

If I had my choice between $75k of income and $150k which included $75k of LTCG, I would choose option B and never give it another thought.

There comes a time where depriving the tax man means a substantial lowering in standard of living...

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by investorpeter » Sun Oct 01, 2017 11:40 pm

CurlyDave wrote:
Sun Oct 01, 2017 11:28 pm
If I had my choice between $75k of income and $150k which included $75k of LTCG, I would choose option B and never give it another thought.

There comes a time where depriving the tax man means a substantial lowering in standard of living...
I hear ya. Tax efficiency does get to be kind of a self-defeating game at some point. But $75k is about what we are used to spending per year. And I agree that lowering standard of living Is not worth it. That is why I would not consider lowering income to get the full ACA subsidy.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by FiveK » Sun Oct 01, 2017 11:44 pm

investorpeter wrote:
Sun Oct 01, 2017 11:13 pm
In my case, the LTCGs are about 2x the amount in tax deferred accounts, and the cost basis on the LTCGs is almost negligible due to holding some individual stocks for a very long time....
It may well be that a financial comparison of TGH vs. Roth conversion would favor the Roth conversion, assuming equal risks of the investments held in each and a sufficient elapsed time.

With so much unrealized LTCG held in (a few?) individual stocks, favoring selling those and converting the proceeds to something (e.g., index funds) less risky is not at all unreasonable, even if that reduces the amount of tIRA->Roth you can do prior to RMDs and SS.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by FiveK » Sun Oct 01, 2017 11:45 pm

technovelist wrote:
Sun Oct 01, 2017 10:50 pm
FiveK wrote:
Sun Oct 01, 2017 10:08 pm
MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.
I get $16,619 after updating my calculator with the 2017 brackets, exemptions, and so on.
Yes, same number.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Mon Oct 02, 2017 12:25 am

FiveK wrote:
Sun Oct 01, 2017 11:45 pm
technovelist wrote:
Sun Oct 01, 2017 10:50 pm
FiveK wrote:
Sun Oct 01, 2017 10:08 pm
MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.
I get $16,619 after updating my calculator with the 2017 brackets, exemptions, and so on.
Yes, same number.
Thanks for the confirmation.

Now all I have to do is redo my 100 or so regression tests that probably are all broken due to the changes. :annoyed
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Tue Oct 03, 2017 12:19 pm

FiveK wrote:
Sun Oct 01, 2017 11:45 pm
technovelist wrote:
Sun Oct 01, 2017 10:50 pm
FiveK wrote:
Sun Oct 01, 2017 10:08 pm
MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.
I get $16,619 after updating my calculator with the 2017 brackets, exemptions, and so on.
Yes, same number.
I'm getting a slightly different number by using the spreadsheet at (https://sites.google.com/site/excel1040/home), but it's the 2016 version. Is the 2017 version up yet, or am I using the wrong calculator?
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by FiveK » Tue Oct 03, 2017 12:40 pm

technovelist wrote:
Tue Oct 03, 2017 12:19 pm
FiveK wrote:
Sun Oct 01, 2017 11:45 pm
technovelist wrote:
Sun Oct 01, 2017 10:50 pm
FiveK wrote:
Sun Oct 01, 2017 10:08 pm
MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.
I get $16,619 after updating my calculator with the 2017 brackets, exemptions, and so on.
Yes, same number.
I'm getting a slightly different number by using the spreadsheet at (https://sites.google.com/site/excel1040/home), but it's the 2016 version. Is the 2017 version up yet, or am I using the wrong calculator?
Depends what you mean by "wrong". The spreadsheet I used has 2017 tables, and is referenced in Tools and calculators - Personal_finance_toolbox - Bogleheads.

Perhaps the most accurate calculators are embedded in TurboTax, TaxAct, etc., as mentioned in Tax Modeling for 2017. The "finance toolbox" spreadsheet seems to have all the "common" exceptions, such as saver's credit, EITC, etc. on the low end, and NIIT, Pease limitation, AMT, etc. on the high end.

Regarding "slightly" the toolbox spreadsheet did come up with $16,618 IIRC but I know it uses algebra instead of lookup tables when it calculates federal tax, so "close enough".

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by J295 » Tue Oct 03, 2017 12:55 pm

Another factor to consider, is whether OP will want to be eligible for premium tax credits under the ACA (under current law), as MAGI for family of two to receive credits is less than $75k.

If charitably inclined might also consider a donor advised fund.

We are aware of this tax feature, but it wasn't a material factor in our early retirement decision

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Tue Oct 03, 2017 3:34 pm

FiveK wrote:
Tue Oct 03, 2017 12:40 pm
technovelist wrote:
Tue Oct 03, 2017 12:19 pm
FiveK wrote:
Sun Oct 01, 2017 11:45 pm
technovelist wrote:
Sun Oct 01, 2017 10:50 pm
FiveK wrote:
Sun Oct 01, 2017 10:08 pm
MFJ both 67 with $40K pension, $35K SS, $100K LTCG/QD, and standard deduction, would pay ~$16,600 federal income tax for 2017, based on this tax calculator.
I get $16,619 after updating my calculator with the 2017 brackets, exemptions, and so on.
Yes, same number.
I'm getting a slightly different number by using the spreadsheet at (https://sites.google.com/site/excel1040/home), but it's the 2016 version. Is the 2017 version up yet, or am I using the wrong calculator?
Depends what you mean by "wrong". The spreadsheet I used has 2017 tables, and is referenced in Tools and calculators - Personal_finance_toolbox - Bogleheads.

Perhaps the most accurate calculators are embedded in TurboTax, TaxAct, etc., as mentioned in Tax Modeling for 2017. The "finance toolbox" spreadsheet seems to have all the "common" exceptions, such as saver's credit, EITC, etc. on the low end, and NIIT, Pease limitation, AMT, etc. on the high end.

Regarding "slightly" the toolbox spreadsheet did come up with $16,618 IIRC but I know it uses algebra instead of lookup tables when it calculates federal tax, so "close enough".
That's the link I used but there are a number of different spreadsheets there. Could you tell me the exact URL for the spreadsheet you used?

The one I used was downloaded from http://www.excel1040.com.

That spreadsheet uses 2016 brackets, etc., and calculates $16,747 vs. $16,619 that I calculated myself.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by FiveK » Tue Oct 03, 2017 3:58 pm

technovelist wrote:
Tue Oct 03, 2017 3:34 pm
FiveK wrote:
Tue Oct 03, 2017 12:40 pm
Depends what you mean by "wrong". The spreadsheet I used has 2017 tables, and is referenced in Tools and calculators - Personal_finance_toolbox - Bogleheads.
That's the link I used but there are a number of different spreadsheets there. Could you tell me the exact URL for the spreadsheet you used?
When you click that link, is this the first thing you see? (note: it's merely a picture here)
Image

If so, either of those links will take you to the spreadsheet. The first provides some context, while the second brings up the spreadsheet.

If that is not the first thing you see, please say what is.

The direct link is https://drive.google.com/file/d/0B45krB ... BHVXc/view.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by technovelist » Tue Oct 03, 2017 10:58 pm

Ok, thanks. That didn't say "Federal tax calculator", so I didn't recognize it as the spreadsheet in question.
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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by aristotelian » Wed Oct 04, 2017 6:57 am

If you are unsure, you could always split the difference and do some of each. Diversification.

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Re: Tax Strategy for Timing of Early Retirement with Significant Long-Term Capital Gains

Post by Bacchus01 » Wed Oct 04, 2017 7:24 am

I love these threads. Thank you guys!

I want to retire early, maybe as early as 47, and these threads really help with planning. I had been assuming in retirement that we'd be paying ~25% in fed taxes but you are showing ways to live off $100k a year or less, and paying much lower taxes.

Thanks

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