Author Topic: Capital Gains Tax and the MMM Approach  (Read 7039 times)

HK-Expat

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Capital Gains Tax and the MMM Approach
« on: February 06, 2014, 07:45:12 PM »
I have a question about how potential capital gains taxes factor into the Mustachian approach:  Specifically, if one is generating 25x annual expenses from one's portfolio, won't periodic asset reallocations have the potential to radically reduce that through capital gains taxes?

Do people use any kind of formula or other approach to factor in the effects of this on the amount you need or the timing of retirement? 

This has been nagging at me as I try to calculate my "number", what I expect to need and when I would be able to retire.  Many thanks in advance!

foobar

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Re: Capital Gains Tax and the MMM Approach
« Reply #1 on: February 06, 2014, 08:20:22 PM »
Use your tax deferred accounts and high cost basis assets and you will not generate much in the line of capital gains even during the accumulation phase. You can also use your savings to balance things out.

In the spending part, you can get almost 100k (assuming married) of capital gains tax free so it shouldn't be much of an issue there either.


I have a question about how potential capital gains taxes factor into the Mustachian approach:  Specifically, if one is generating 25x annual expenses from one's portfolio, won't periodic asset reallocations have the potential to radically reduce that through capital gains taxes?

Do people use any kind of formula or other approach to factor in the effects of this on the amount you need or the timing of retirement? 

This has been nagging at me as I try to calculate my "number", what I expect to need and when I would be able to retire.  Many thanks in advance!

Cheddar Stacker

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Re: Capital Gains Tax and the MMM Approach
« Reply #2 on: February 07, 2014, 04:01:47 PM »
Foobar is referring to the 0% capital gains tax for people in the 10% and 15% tax brackets. If you're currently working and making a nice wage, you might not be in the 15% bracket. In that case, mess with your asset allocation in your tax deferred accounts since there is no tax. Once you're retired, you can take qualified dividends and long-term capital gains of up to $36,250 (single) and $72,500 (married) without paying any tax based on the current laws. These are 2013 #'s.

Read this: http://www.gocurrycracker.com/never-pay-taxes-again/

Eric

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Re: Capital Gains Tax and the MMM Approach
« Reply #3 on: February 07, 2014, 04:04:53 PM »

Read this: http://www.gocurrycracker.com/never-pay-taxes-again/

You got me hooked on that blog!  I read it start to finish two weeks ago.  I can't wait to hear about their adventures in Cuba.

Cheddar Stacker

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Re: Capital Gains Tax and the MMM Approach
« Reply #4 on: February 07, 2014, 04:09:46 PM »
It's an interesting way to live. I'm not sure if their permanent slow travel is for me, particularly with my 2 young kids, but I love to read about their travels.

Also, my god the never pay taxes again post is really eye opening. For people who plan to have little earned income early in life, this is a goldmine of a strategy.

HK-Expat

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Re: Capital Gains Tax and the MMM Approach
« Reply #5 on: February 07, 2014, 04:14:24 PM »
Thanks for your responses, everyone.  Very helpful, and I obviously have a lot to learn about tax strategy and the like.

toga62

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Re: Capital Gains Tax and the MMM Approach
« Reply #6 on: February 08, 2014, 12:57:24 AM »
Foobar is referring to the 0% capital gains tax for people in the 10% and 15% tax brackets. If you're currently working and making a nice wage, you might not be in the 15% bracket. In that case, mess with your asset allocation in your tax deferred accounts since there is no tax. Once you're retired, you can take qualified dividends and long-term capital gains of up to $36,250 (single) and $72,500 (married) without paying any tax based on the current laws. These are 2013 #'s.

Read this: http://www.gocurrycracker.com/never-pay-taxes-again/

Wow this just blew my mind.  Can someone confirm a scenario then for me?

Lets say I have 3 accounts;
Traditional IRA
Roth IRA
Regular (taxable) Investment Account

Lets say I've grown nest eggs in all 3 accounts over a lengthy time and have decided to retire early.

So if I had my traditional IRA growing tax-free, and I'm (early) retired with no real income, I can roll part of that money over into a Roth IRA each year and have it counted towards my yearly income but as long as it is below the minimum amount needed to fall into the lowest tax bracket I will not be taxed on it right?

I can then withdraw that money from the Roth IRA since it is counted as a contribution (or principle) added to the Roth IRA, and principle can be withdrawn without penalty from a Roth IRA before age 59.5 right?

I can then make capital long-term gains or dividends of up to 70K (or whatever the max is) from my regular investment account and not have to pay capital gains taxes on these earnings because I have no taxable income?

In addition, I could in actuality make up to the maximum contribution amount for my Traditional IRA in real income each year as long as it all goes into the Traditional IRA and isn't counted towards my income for the year. right?

Seriously, if all that is accurate then that is freaking genius.

Questions:
I can't find much info on if a rollover to a Roth IRA is considered principle, can anyone confirm this?
Also, if I make continued gains / dividends in my regular investment account, are they really not taxable up to a certain earnings amount if I'm under the minimum income needed to pay taxes? Or does this only apply to earnings in my IRAs?

Cheddar Stacker

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Re: Capital Gains Tax and the MMM Approach
« Reply #7 on: February 08, 2014, 09:09:54 AM »
All absolutely correct, except:

-When you convert from TIRA to ROTH IRA there is a 5 year waiting period before touching the principal. Contributions you made straight to the ROTH are eligible for withdrawal at any time.

-There isn't any need to contribute to a TIRA anymore once you begin implementing this strategy, unless you screw something up and end up over the 15% bracket, in which case a TIRA contribution might, let me stress that, MIGHT, get you back down to non-taxable Qdivs and L-T Cap Gains. I'm not sure about that one, I'd have to play with it to know for sure.

Answers to questions at the bottom: See the first point above, and yes, qualified dividends and long-term capital gains are not taxed until you get to the 25% tax bracket. Interest, non-qualified dividends, and short term capital gains are all taxed in every tax bracket, so those would still count.

All of this is obviously subject to change so step carefully, but the 0% tax on the 10-15% bracket came into play with the bush era tax cuts and was made permanent recently. The TIRA to Roth rollover rule has been liberalized since 2010 to include people with higher AGI's. All of this could go away, but this is the current structure we have.

State taxes are a whole different issue, so check local listings.

And read this: http://www.mrmoneymustache.com/forum/ask-a-mustachian/4-withdraw/msg187544/#msg187544 which I posted in another thread. With a wife and 2 small kids, I would be able to get to about $96K AGI and pay no federal tax if I had the assets to do so. This is what I hope to do in about 5 years.

Joel

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Re: Capital Gains Tax and the MMM Approach
« Reply #8 on: February 08, 2014, 09:38:00 AM »
Keep in mind that qualified dividends and long term capital gains are tax free when your taxable income falls within the 15% tax bracket. For an individual that is approximately 36k currently, but if you have 20k in ordinary income, only 16k of those qualified dividends or long term capital gains are tax free. You can actually end up in a situation where your marginal tax rate is 30% if you have a significant amount of qualified dividends and long term capital gains and are straddling two different marginal tax brackets.

Cheddar Stacker

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Re: Capital Gains Tax and the MMM Approach
« Reply #9 on: February 08, 2014, 11:01:10 AM »
Keep in mind that qualified dividends and long term capital gains are tax free when your taxable income falls within the 15% tax bracket. For an individual that is approximately 36k currently, but if you have 20k in ordinary income, only 16k of those qualified dividends or long term capital gains are tax free. You can actually end up in a situation where your marginal tax rate is 30% if you have a significant amount of qualified dividends and long term capital gains and are straddling two different marginal tax brackets.

Good points.

However, that's why the strategy includes "leisure over work" so you avoid ordinary income. Also, you have approximately $10K/individual of tax free ordinary income due to the standard deduction and exemption, so that would reduce your $20K ordinary down to $10K ordinary which is almost all in the 10% bracket so your federal income tax would be just over $1K.

Jeremy

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Re: Capital Gains Tax and the MMM Approach
« Reply #10 on: March 23, 2014, 10:11:24 PM »
Hi everybody, as a follow up to our original Never Pay Taxes Again, I've shared our 2013 1040's on the blog with some explanations.

We were able to take advantage of all of the tax minimization techniques, resulting in over $90k in adjusted gross income with ZERO tax

http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/

Cheddar Stacker

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Re: Capital Gains Tax and the MMM Approach
« Reply #11 on: March 24, 2014, 08:45:11 AM »
Great post Jeremy, very nice to actually see this in action. Thanks for the link on this thread as well.

I've often thought once I retire that I'd get creative with the occupation line on my tax return. May I suggest for you:

-Investor
-World Traveler
-Writer
-Curry Cracker-er
-Baller

I'm not sure how the IRS might respond, but what's the worst that could happen right? Safe travels sir.

nottoolatetostart

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Re: Capital Gains Tax and the MMM Approach
« Reply #12 on: March 24, 2014, 08:57:10 AM »
Great post Jeremy, very nice to actually see this in action. Thanks for the link on this thread as well.

I've often thought once I retire that I'd get creative with the occupation line on my tax return. May I suggest for you:

-Investor
-World Traveler
-Writer
-Curry Cracker-er
-Baller

I'm not sure how the IRS might respond, but what's the worst that could happen right? Safe travels sir.

Haha! I had to go back and read what they wrote for occupation.

Thanks Jeremy for posting. Safe travels!

MDM

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Re: Capital Gains Tax and the MMM Approach
« Reply #13 on: March 24, 2014, 10:19:21 AM »
Paul Krugman wants to take this (MMM approach to dividends and capital gains) away from you: http://www.nytimes.com/2014/03/24/opinion/krugman-wealth-over-work.html?_r=0

To be fair to Paul, he is aiming at 6 people, not at you or me - but would hit a large swath of FIRE folks if he got his way.

Chuck

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Re: Capital Gains Tax and the MMM Approach
« Reply #14 on: March 24, 2014, 12:24:25 PM »
Paul Krugman wants to take this (MMM approach to dividends and capital gains) away from you: http://www.nytimes.com/2014/03/24/opinion/krugman-wealth-over-work.html?_r=0

To be fair to Paul, he is aiming at 6 people, not at you or me - but would hit a large swath of FIRE folks if he got his way.
Krugman... There was never a smarter fool that ever lived...

Jamesqf

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Re: Capital Gains Tax and the MMM Approach
« Reply #15 on: March 24, 2014, 12:36:48 PM »
To be fair to Paul, he is aiming at 6 people, not at you or me - but would hit a large swath of FIRE folks if he got his way.

He's also doing a good job of cherry picking.  6 of the top 10, but 9 of the top 20, 10 of 40...

it could also be argued that the Koch brothers shouldn't be counted in the 6 of 10, as their inherited wealth wouldn't have got them in the top 400.
« Last Edit: March 24, 2014, 12:39:20 PM by Jamesqf »

anisotropy

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Re: Capital Gains Tax and the MMM Approach
« Reply #16 on: March 24, 2014, 01:07:20 PM »
Cool, how do we do that in Canada?

Jeremy

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Re: Capital Gains Tax and the MMM Approach
« Reply #17 on: March 24, 2014, 06:39:44 PM »
Paul Krugman wants to take this (MMM approach to dividends and capital gains) away from you: http://www.nytimes.com/2014/03/24/opinion/krugman-wealth-over-work.html?_r=0

To be fair to Paul, he is aiming at 6 people, not at you or me - but would hit a large swath of FIRE folks if he got his way.

I wouldn't be opposed to changes to the tax law.  I think it would be better for society as a whole

I don't think it is going to happen though, no matter how many articles Krugman writes.

Jeremy

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Re: Capital Gains Tax and the MMM Approach
« Reply #18 on: March 24, 2014, 06:41:03 PM »
Great post Jeremy, very nice to actually see this in action. Thanks for the link on this thread as well.

I've often thought once I retire that I'd get creative with the occupation line on my tax return. May I suggest for you:

-Investor
-World Traveler
-Writer
-Curry Cracker-er
-Baller

I'm not sure how the IRS might respond, but what's the worst that could happen right? Safe travels sir.

I considered going with Beach Bum, but Curry Cracker-er really appeals to me for some reason :-D