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Living Off Taxable Brokerage Earnings 100% Tax-FREE

My favorite investment account is my Roth IRA. It doesn’t get much better than an investment account that:

  1. Allows you to choose and invest in practically any investment security (stocks, bonds, index funds, ETFs, REITs, etc.) you could want
  2. Grows tax-free
  3. Withdrawals at age 59.5 become 100% tax-free

The Roth IRA is one of the few things the government has actually done correctly to help the average person save for retirement, but it does have one major drawback. That drawback is the annual $6,000 maximum contribution limit ($7,000 if you are over 50). So while the government was nice enough to give us this type of investment account, they cap how much you are allowed to contribute to it every year.

Now, what if I told you there was another investment account option that operates very similar to a Roth IRA, doesn’t have the annual contribution limit drawback, but also doesn’t have penalty fees if you want to withdraw the money before age 59.5!?

Sounds almost too good to be true, but such an account does exist, and many of us either have already heard of it or have opened one already. That account is a simple ordinary regular taxable brokerage account:

  1. The investor contributes post-tax money (like Roth IRA contributions), but has NO contribution limits (meaning you can invest however much you want)!
  2. Account does NOT grow tax-free (different from Roth IRA), you will owe annual taxes on capital gains (profits from selling an asset for more than what you paid), dividends, and interest
  3. Dividends/Interest are taxed in the year they’re realized (e.g. dividends/interest distributed to you from Jan 1, 2022 – Dec 31, 2022, will be filed in your 2022 taxes)
  4. Capital gains will be either taxed as short-term (assets held < 1 year) or long-term (assets held > 1 year) capital gains

If you’re looking to secure short-term profits, you’ll owe more in taxes because short-term capital gains are taxed (generally) at the same rate as your regular income. If you’re willing to hold your assets (and earnings) for more than 1 year, then you benefit from your earnings being taxed at the lower long-term capital gains rate.

This is where the potential “living off your taxable brokerage 100% tax-FREE” comes into play…

For 2022, here are the long-term capital gains tax rates:

For most individuals reading this, you likely either fall into the single or married filing jointly tax status. What you want to pay attention to in the table above (highlighted in RED) is the capital gains income limits for the 0% long-term tax rate:

  1. Single <=$41,675
  2. Married, filing jointly <=$83,350
  3. Married, filing separately <=$41,675
  4. Head of household <$55,800

What this means is if you can keep ALL your reportable income (including 9-5 job salary) underneath the 0% long-term capital gains rate, then your investment earnings from your taxable brokerage can be taxed at 0% federally (state & local taxes may still apply depending on where you live)!

This is actually a strategy my wife and I plan to use in early retirement, which will be sometime in our late-40s. Here is an example of how that would work for us:

  1. Retire from our 9-5’s so that we are no longer earning any income from a job (reporting $0 in wage income on our taxes)
  2. Live off our taxable brokerage dividends/capital gains (selling shares we’ve held > 1 year so they’re taxed at the lower long-term capital gains rate)
  3. Make sure that the total $ amount we live off of (between dividends and selling shares) is beneath the 0% income rate (e.g. $83,350 for married filing jointly)

So while taxable brokerages do not grow-tax-free like Roth IRAs, they have the potential to be withdrawn from (100% tax-free) like Roth IRAs *IF* you can hold your assets (and earnings) for longer than 1-year and you are careful in how much you withdrawal from your account.

This is a strategy many FIRE (financially independent retired early) people utilize in early retirement, and it’s definitely a nice little trick for you to keep up your sleeve in your investment planning!

2 comments

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tharri12@gmail.com

Great info! Thanks

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The Wealth DadCreator

Glad to hear you enjoyed it!

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