Holy Moly Guacamole! (I say this phrase often to my boyfriend in real life.) I just learned something super awesome and I want to share with everyone! Apparently, there is a nice little loophole that can allow you to reduce or, in some cases, completely do away with capital gains and dividend taxes on your brokerage account!
I guess this isn’t really a “loop hole” or even really a secret once you become well-versed in the world of investing but it literally blew my mind once I found out this was a thing. Let me explain why I was even looking into this. First of all, I am not eligible to contribute to my company’s 401k account until after being there for a year and a half. It’s one of the worst benefits that they have and, honestly, I can’t believe that it exists at all. They weren’t very forth coming about this information before I started even though I specifically asked about the 401k and they actually lead me to believe something completely untrue about this benefit. Anyway, I digress. The point is, because of this situation with the company I work for I had to open up a taxable brokerage account in addition to my Roth IRA if I wanted to stay on track with my plans of early retirement.
After opening my taxable brokerage account, I had literally just resigned myself to paying double the taxes on that money. I didn’t know much about the tax situation at the time so I just thought it was a fact of life. As it turns out you can actually withdraw up to a certain amount and literally pay zero capital gains and dividend taxes! It always makes more sense when there are examples so I’m going to provide a hypothetical situation below.
Let’s say you’re in your mid-40s and you’ve been saving your whole life into a taxable brokerage account. By the time you reach 45, you have accumulated $1,000,000. You decide to work to the very end of the year of the year you turn 45 and start your early retirement on Jan 1st of the following year (in this case, we are going to assume this year is Jan 1, 2018). You have zero “earned” income that year, meaning you didn’t work and you didn’t have any income from rental property. Let’s also say that you plan to withdraw from your taxable brokerage account 4% so you don’t deplete your initial amount. So 4% from 1 million dollars is just $40,000. It’s a nice number that most people can make do on. Since this $40,000 will be “unearned” money, meaning you didn’t work for it and you didn’t obtain if from rental properties, you would owe no federal taxes on it because you already paid taxes on it before you put it into the account. Also, you would not owe any capital gains taxes on the amount from $0 to $38,600. Since you are withdrawing $40,000 during the year of 2018 (hypothetically), you would owe capital gains of the amount from $38,600 to $40,000 in the amount of 15%.
It’s also worthwhile to note that even though you wouldn’t owe federal taxes or long-term capital gains taxes on most of the $40,000 you decided to withdraw, you would still be responsible for your state taxes on that money if you live in a state that has state income taxes. It’s also worth noting too that this scenario only holds true on long-term capital gains, meaning that you had to hold that investment for 12 months or longer.
If you want more information about this click here and read the article that nerdwallet wrote on this subject. There’s also a neat little calculator that you can use to see what your tax liability would be in other hypothetical situations.
Thanks for reading, everyone! I sure hope this information was as mind blowing to you as it was me!