Ah, the traditional pleasures of September. Summer's heat starts to fade. Pumpkin-spice-flavored everything begins to appear on menus. People get in their first complaints of the year at seeing retailers roll out the Christmas marketing before they've even picked out their Halloween costumes. And, of course, the month would not be complete without a mailbag show from Motley Fool Answers hosts Alison Southwick and Robert Brokamp. To help them address all your autumnal financial conundrums, Sean Gates, a financial planner with Motley Fool Wealth Management, returns to the studio.
In this segment, they consider the case of a man whose investments have accrued him a large quantity of qualified dividends. Could he really owe Uncle Sam nothing for his gains? And if that's right, is cutting his tax bill to zero now actually the best long-term strategy for him?
A full transcript follows the video.
This video was recorded on Sept 25, 2018.
Alison Southwick: The first question comes from Eric. "I have been doing some research into how to minimize my tax burden in retirement and have been using the TurboTax TaxCaster. Just as an experiment, I entered the following information, and it said I would not owe any taxes for 2018." Are you ready?
Robert Brokamp: We're ready!
Southwick: "Single. Head of household. Age 48. Taxable wages, zero. Qualified dividends, $65,000. Is this true or is there a catch?"
Sean Gates: Yes, so this is true. There is no tax due because of the preferred nature of qualified dividends. So if you're head of household, that means you're sort of coupled up to some extent and the limits for that preferential rate can range, as a single person, from $0.00 to $38,600 [or] if you switch over to the married, filing jointly; $0.00 to $77,200. If you fall in those ranges your capital gains rates and your qualified dividends rates are at 0%, so you don't owe any taxes on it.
Now, you want to keep in mind that qualified dividends are a very specific type of result from a particular investment, and so you're concentrating yourself into a particular type of investment to get that tax qualification. I just want to make sure that you understand how that affects your overall diversification investment portfolio.
Brokamp: And by capital gains you mean long-term capital gains, of course; not short-term capital gains.
Gates: Correct. Exactly.
Brokamp: And it could even be better, for Eric's looking at this at age 48. Once you're 65 you get a higher standard deduction and, of course, in retirement you get Social Security and at least part of your Social Security is tax-free; so really, there are a lot of ways where you'll pay much less taxes in retirement.
Gates: And one other thing to keep in mind. In this case, particularly, you're looking at the current year and you get really excited because you see, "Oh, man I'm not going to pay anything in taxes." But what you really should start to think about is your lifetime tax liability, because if you're 48 and you have no taxable income; yes, you'll get the qualified dividends rate but maybe you could consider pulling money from your IRA early [now you have to be mindful of potential penalties and it gets complicated], but you could harvest income strategically in those low-income tax rates to potentially avoid future tax liability that might be higher because of things that Bro mentioned.
