Living off long term capital gains

[Neverstop]

I just recently discovered this article http://www.madfientist.com/traditional-ira-vs-roth-ira/ which explains how to use a roth and traditional IRA to its best advantage by slowly converting a traditional IRA into a roth during early retirement and living off of your long term capital gains which wil be taxed at 0%.

What exactly are long term capital gains? I know that they are defined as assets that are held for more than one year, but how can you get long term capital gains? Are those only from after tax investments liked index funds and roth iras?

[johnny847]

Go curry cracker is probably the best blogger on the subject, as he and his wife are executing what they preach http://www.gocurrycracker.com/never-pay-taxes-again/

In short yes long term capital gains are the profits (current market value less cost basis) of assets held for at least one year. You can get them buy buying assets such as stocks and mutual funds.


IRAs, both Roth and traditional, are not taxed at long term rates. Your withdrawals are taxed as normal income.

[Indexer]

LTCG are gains on investments that you've held for one year and then you sell at a gain. Buy at 10, hold for a year, sell at 12, LTCG is 2.

Now what is important is the tax impact. Short term capital gains on investment you held for less than 1 year are taxed as ordinary income.

LTCG and qualified dividends(most stock dividends you will run into are qualified, that is all you need to know) are taxed on a different tax table than ordinary income and it is an amazing table to be on.

Ordinary income tax bracket/ LTCG tax bracket.
10/ 0%
15/ 0%
25/ 15%
33/ 15%
etc.

Notice if you are in a lower tax bracket, 10-15% brackets, LTCG are taxed at ZERO! Even if you are in the 25-35 its only 15%. Even at the highest tax bracket, almost 40%, LTCGs are taxed at 20%.

[Rubic]

For a simple explanation of the current status of long-term capital gains, the Wikipedia article is informative:

https://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States

For example, in my case, once FIRE'd, I could easily live on $37,650 + basis costs per year from my taxable accounts for many years before paying a dime in income tax(*), probably until social security kicks in.  I often emphasize that taxable investment accounts are under-appreciated in retirement planning.

(*) Since I'll spend a few years doing Roth conversions, my retirement won't be completely tax-free.

[johnny847]

Go curry cracker is probably the best blogger on the subject, as he and his wife are executing what they preach http://www.gocurrycracker.com/never-pay-taxes-again/

In short yes long term capital gains are the profits (current market value less cost basis) of assets held for at least one year. You can get them buy buying assets such as stocks and mutual funds.


IRAs, both Roth and traditional, are not taxed at long term rates. Your withdrawals are taxed as normal income.

Roth contributions are taxed at regular income tax rates the year you earn the income/make the contribution. But wihdrawals of your contribution amounts are tax free thereafter, and withdrawals if any earnings are also tax free after age 59.5 and are NOT counted as income.  That is the whole point of the Roth - pay the taxes up front and enjoy the returns tax free later.

Yeah that was a complete brain fart. I should've said traditional IRA withdrawals.

[seattlecyclone]

To be clear, long-term capital gains only occur on assets that you hold in a taxable account (i.e. not in retirement accounts such as an IRA or 401(k)). The Mad Fientist article was written from the perspective of someone who can afford to max out their retirement accounts and then invest some more money beyond that.

The Roth conversion ladder works best when you have five years' worth of savings that you can access penalty-free while your Roth conversions season. This can include taxable investments, HSAs, and direct Roth contributions. That's not to say that you should prioritize taxable investments over retirement accounts until you have five years' worth outside of retirement accounts, just that it's even better if you can do both.

[Neverstop]

How do you avoid the 10% penalty for early withdrawal when doing this?

[johnny847]

How do you avoid the 10% penalty for early withdrawal when doing this?

http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

[cdm]

The short term vs. long term gain distinction only matters to a taxable account.
Withdrawals from a traditional IRA are taxed at ordinary rates no matter whether they are long term gains or short term gains.
Withdrawals from a ROTH IRA are not taxed no matter whether if the are short term or long term gains.


Note that withdrawals from a traditional IRA or ROTH IRA could be penalized if your are under 59 1/2 unless you take them out in a prescribed manner. Your initial contributions must also have been made to your ROTH IRA five years before the date when you start withdrawing funds.

[Greenpez]

The short term vs. long term gain distinction only matters to a taxable account.
Withdrawals from a traditional IRA are taxed at ordinary rates no matter whether they are long term gains or short term gains.
Withdrawals from a ROTH IRA are not taxed no matter whether if the are short term or long term gains.


Note that withdrawals from a traditional IRA or ROTH IRA could be penalized if your are under 59 1/2 unless you take them out in a prescribed manner. Your initial contributions must also have been made to your ROTH IRA five years before the date when you start withdrawing funds.

For ROTH. Contributions can be removed at any point after they are made. Conversions must wait 5 years. Growth is after 59 1/2.

[cdm]

...

Your initial contributions must also have been made to your ROTH IRA five years before the date when you start withdrawing funds.

For ROTH. Contributions can be removed at any point after they are made. Conversions must wait 5 years. Growth is after 59 1/2.

Yes, I stated that poorly. You can withdraw your initial contributions from your Roth IRA prior to 5 years but then gains would not be considered a qualified distribution and would be taxable.
Detailed rules are here: https://www.irs.gov/publications/p590b/ch02.html

[johnny847]

Guys Roth isn't an acronym. No need to capitalize it.

[Greenpez]

Guys Roth isn't an acronym. No need to capitalize it.

  Thank you for this contribution. Keep fighting the good fight.

[seattlecyclone]

Yes, I stated that poorly. You can withdraw your initial contributions from your Roth IRA prior to 5 years but then gains would not be considered a qualified distribution and would be taxable.

You seem to be implying that if someone withdraws their Roth IRA contributions less than five years after opening their account, they can never make a qualified distribution on the gains. This is not true. Every distribution from your IRA is considered individually for the purpose of determining whether it is a qualified distribution. Making a non-qualified distribution of your contributions does not disqualify you from making a qualified distribution of the gains when you become eligible to do so.

[Greenpez]

...

Your initial contributions must also have been made to your ROTH IRA five years before the date when you start withdrawing funds.

For ROTH. Contributions can be removed at any point after they are made. Conversions must wait 5 years. Growth is after 59 1/2.

Yes, I stated that poorly. You can withdraw your initial contributions from your Roth IRA prior to 5 years but then gains would not be considered a qualified distribution and would be taxable.
Detailed rules are here: https://www.irs.gov/publications/p590b/ch02.html

 I don't see anything there that states gains are taxable if the contributions they are from are removed prior to 5 years. Could you be more specific?

[cdm]

...

Your initial contributions must also have been made to your ROTH IRA five years before the date when you start withdrawing funds.

For ROTH. Contributions can be removed at any point after they are made. Conversions must wait 5 years. Growth is after 59 1/2.

Yes, I stated that poorly. You can withdraw your initial contributions from your Roth IRA prior to 5 years but then gains would not be considered a qualified distribution and would be taxable.
Detailed rules are here: https://www.irs.gov/publications/p590b/ch02.html

 I don't see anything there that states gains are taxable if the contributions they are from are removed prior to 5 years. Could you be more specific?

See Figure 2-1 in  https://www.irs.gov/publications/p590b/ch02.html

Has it been at least 5 years from the beginning of the year for which you first opened and contributed to a Roth IRA. ?
If "No" Then
The distribution from the Roth IRA is not a qualified distribution. The portion of the distribution allocable to earnings may be subject to tax and it may be subject to the 10% additional tax.

Here is another article that discusses the 5 year rules https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

[seattlecyclone]

You're misreading it. Yes, if your IRA has been open less than five years or if you're still under 59.5 years old your distribution will not be qualified. Any earnings that you take out as part of that distribution may be subject to taxes. But if you leave the earnings in the account and take them out as a qualified distribution later, there's no tax.

[Greenpez]

You're misreading it. Yes, if your IRA has been open less than five years or if you're still under 69.5 years old your distribution will not be qualified. Any earnings that you take out as part of that distribution may be subject to taxes. But if you leave the earnings in the account and take them out as a qualified distribution later, there's no tax.

 This

[Indexer]

Let me simplify this Roth talk. Think of it from the IRS point of view.

Contributions were already taxed, you can take them back out. The IRS doesn't care.

Conversions. If you took money from a traditional IRA prior to age 59 1/2 there would be a penalty. The IRS doesn't want you to just convert an IRA to a Roth then withdraw the money a week later to avoid potential penalties you would have had on the IRA. So they require you leave the money in the Roth for 5 years after a conversion. Otherwise anyone could avoid IRA penalties by just doing a conversion and then withdrawal.

Withdrawals of growth. Like an IRA you have to wait till 59 1/2. This is retirement money after all. Now the IRS doesn't want someone who is already past 59 1/2 to start a Roth so they can use it like a tax free checking account. So they impose the 5 year rule. You have to wait 5 years from the initial contribution or till age 59 1/2, whichever is later, to withdrawal the growth. Note if you started the Roth prior to age 54 1/2 you don't need to worry about this 5 year rule. Make your life easy and forget it exists. It only affects people who made their initial contribution after 54 1/2.