Mustachians can pay 0% federal capital gains tax?

[finance_hacking]

My entire approach to FI revolves around index funds, bond funds, etc.  I have no desire to become involved in real estate and be a landlord (but that is a different topic).  When it comes to investing my 'Stache, Vanguard is the primary place I look.

I've been doing some research on capital gains taxes and how it would affect my 'Stache once I reach FI.  The government has set the long-term capital gains tax at 0% for taxpayers at the 15% ordinary income tax bracket or lower.  For single filers, such as myself, this means that I only have to pay long-term capital gains taxes on income from my 'Stache if my total income is over $36,250.  And that number seems more than adequate for your average mustachian!

I'm not a tax expert, but my understanding is that I won't have to pay any federal income tax once I reach FI and start living off of my 'Stache, provided I don't take out more than $36,250 each year.  I believe that this makes it even easier for me to reach FI with my 'Stache.

Obviously, there are a few caveats:
1. States may tax capital gains as income, so you would still have to pay that.  This can be solved by moving to a state that has a very low income tax rate or no income tax at all.
2. The government may decide to re-institute a capital gains tax for people at the 15% tax bracket and lower.  There is no way to predict the future tax rates, so this is always a risk that can be hard to account for.

Did I miss anything?  Does anyone with a better understanding of how taxes work see any problems with this type of plan?

[DK]

With your standard deduction and personal exemption, you can earn $46250 since the $10K in deductions will still put you in the 15% bracket.

I'm not positive, but from what I understand you will pay 0% on capital gains and qualified dividends as long as your earned income stays in the 15% bracket. So I think even if you earn 46,250, and also take in 5K in capital gains, you still pay zero tax on the 5K even though it raises your moola you bring in to 51,250, since you only get taxed on your earned income.

[finance_hacking]

Oh yea, I forgot about standard deduction.

So I think even if you earn 46,250, and also take in 5K in capital gains, you still pay zero tax on the 5K even though it raises your moola you bring in to 51,250, since you only get taxed on your earned income.

According my research, I don't think this is 100% correct.  But it's pretty complicated, so I don't feel like diving into it.

Anyways, my main fascination with this is that if I keep my entire income within the 15% bracket (included interest, dividends, capital gains, and any part-time side job income) I don't have to worry about paying long-term capital gains taxes at all.

My current spending is under $24k/yr, so I don't think this will be a challenge for me :)

[sol]

I'm not positive, but from what I understand you will pay 0% on capital gains and qualified dividends as long as your earned income stays in the 15% bracket. So I think even if you earn 46,250, and also take in 5K in capital gains, you still pay zero tax on the 5K even though it raises your moola you bring in to 51,250, since you only get taxed on your earned income.

I disagree, it looks like your capital gains income does count towards your total earned income for determining your tax bracket and thus your capital gains tax rate.

But a married couple can still earn up to $72,500 this year before they have to pay any capital gains taxes.  Which is pushing $2mil in stash at 4% SWR before you pay taxes on it, and that's before figuring in the $12,200 standard deduction or the potential additional $3900 exemption per child.

We have three kids at home.  Doing the math, we'd have to be spending $96,400 per year on our family before we had to pay any capital gains.  I think we're safe.

Oh, and don't forget that your withdrawals from your Roth IRAs are also tax free.  Just in case you can't get by on $96k/year.

[Undecided]

And, it's not spending/drawing at that level, it's having income at that level, that flips the taxation. You're also going to have return of basis with your capital gains, so what you draw out isn't going to be all income (unless you've had some really great investments!).

[DK]

I'm not positive, but from what I understand you will pay 0% on capital gains and qualified dividends as long as your earned income stays in the 15% bracket. So I think even if you earn 46,250, and also take in 5K in capital gains, you still pay zero tax on the 5K even though it raises your moola you bring in to 51,250, since you only get taxed on your earned income.

I disagree, it looks like your capital gains income does count towards your total earned income for determining your tax bracket and thus your capital gains tax rate.

But a married couple can still earn up to $72,500 this year before they have to pay any capital gains taxes.  Which is pushing $2mil in stash at 4% SWR before you pay taxes on it, and that's before figuring in the $12,200 standard deduction or the potential additional $3900 exemption per child.

We have three kids at home.  Doing the math, we'd have to be spending $96,400 per year on our family before we had to pay any capital gains.  I think we're safe.

Oh, and don't forget that your withdrawals from your Roth IRAs are also tax free.  Just in case you can't get by on $96k/year.

Good call on calling me out. I was slightly mistaken. Qualified dividends are what I was thinking about. You can get as much qualified dividends as you can and pay $0 tax as long as you stay within the 15% tax bracket on your taxable income. Ordinary dividends, and regular capitol gains DOES contribute to your taxable income, so it could make you go over. I nerded out and figured it out from the following:

http://www.irs.gov/pub/irs-pdf/i1040a.pdf (pg36)
http://www.irs.gov/pub/irs-pdf/f1040a.pdf

With the spending rates, deductions that you both mentioned it looks like it will not be a problem where you will need that much money anyway.

[hoppy08520]

Another nice trick that early retirees might be able to pull off is to pay no income taxes on traditional 401(k) and IRA contributions and withdrawals.

What's the catch? You retire early, have a very low taxable income, and each year you do a Roth contribution with those traditional balances, up to the point where you hit the 10% Federal tax bracket. For a single taxpayer, this could be in the neighborhood of $10,000 - $20,000 annually depending on your personal circumstances, dividend interest income, deductions, etc. If you do this, then you pay 0% going in and 0% going out.

Of course, with a relatively low income you might not have to pay much taxes when you withdraw the traditional contributions anyway, but if you can gradually transfer these balances into Roth anyway, you might as well do it.

[finance_hacking]

Yes, and the 0% capital gains tax for the 15% tax bracket and lower allows you to perform "tax-gain harvesting".

Basically, sell your investments to claim your capital gains, up to the limit for the 15% bracket.  Then immediately re-invest that money in a similar index fund, etc.  (Or re-allocate, if needed).  You've paid 0% capital gains on those gains and now your cost basis is basically 'reset' and you only have to worry about being taxes on future capital gains.

This is useful if you think that a) capital gains tax rates will go up or b) you anticipate having higher income in future years and will be above the 15% tax bracket - possibly due to required IRA distributions, a windfall, etc.

Once I reach FI, I think I will probably tax-gain harvest up to the limit every year.  The only potential downside I see is screwing up the math and ending up paying some taxes.