Your Portfolio’s Income Is Even More Potent Because Of The US Tax Code
I think the above screenshot from Taxcaster tells you everything I’m about to put into words. I used the online calculator to input $13k of gross wages income and added in $40k of long-term capital gains tax, along with $10k of qualified dividends. As you can see my taxable income for my federal tax return would be $49,750. However, because the income wasn’t a wage income but capital gains (i.e. profits from appreciated stocks), it is taxed at a 0% tax rate.
Just for fun, if I ran the same calculation using a gross wage income of $63k without any capital gains or dividend income. This scenario would come out to $6,809 owed to the federal government. Goddamn, that’s a solid weekend’s worth of hookers and blow for a you and your friend, in a 3-star Vegas hotel.
I think playing around with these calculators is very educational. At first it can be confusing but once you compare the various scenarios with each other it gives you a better idea of how the US tax code works.
Qualified Income Breakdown
In the above screenshot I have $13k of gross income which is really easy for us doctors to make, in my case it would be working 1 shift a month (wiping a tear of joy imagining that). Qualified dividends are dividends taxed at lower rates in comparison to non-qualified dividends. A decent portfolio may yield 2% in dividends annually, which means in the example above I would need $500,000 invested in order to get that $10k of dividend income. I’ll add that 2% isn’t a high dividend rate, those who mainly focus on dividend portfolios can get their percentages into the 4% range – requiring a portfolio size of only $250k to generate the above capital gains income.
Long-term capital gains are generally the appreciation of a fund that you’ve had for more than 12 months, I’m not trying to be too technical with this stuff, you can look things up if you want the details. In the example above, $40k in capital gains taxes could be had by selling off $40k of your investment funds. A $300k portfolio that went up by 13% would be worth $340,000. After the withdrawals, this would leave your portfolio at $300,000, not bad at all.
What’s The Value Of This Information
Fortunately, the current tax code is taxing those with wage-income higher than those with capital gains income. This is another argument for needing a lot less money in retirement than you think. If you enjoy the ease of passive income through index funds, perhaps you should focus your investments into this category. A healthy portfolio can generate quite a bit of income.
Any year that you like to add some value to your portfolio, you can pick up a little work, and if you keep that income low enough you can contribute the whole amount to your investments without it getting taxed.
One last point, in this scenario I didn’t add state income taxes. Fortunately, many states mirror the federal tax code and don’t tax your capital gains at high rates. Alternatively, you can move to a zero-tax state upon retirement. I’m not saying that this should be part of your retirement planning, however it’s nice to have options should you find yourself not adequately covered by retirement investments.