The 0% tax rate is meant for lower-income people, and surprisingly, that may include many clients of financial advisors.
“We find this topic is misunderstood and underutilized,” says Kris Gretzschel, manager of the tax and financial planning group at Wells Fargo Advisors in St. Louis. “We look for opportunities to educate our clients on how and when they can take tax-free capital gains, and we also look to take advantage of the 0% tax rate when building a portfolio that will generate retirement income.”
ZERO CAN BE A PLUS
Under the tax code, the 0% rate applies to long-term capital gains and qualified dividends reported by taxpayers in the lowest two brackets (10% and 15%) for ordinary income.
This year, the 15% bracket goes up to $37,450 or $74,900 for married couples filing jointly. Those numbers are for taxable income, after deductions.
Therefore, a retired couple could have $80,000, $90,000 or more in gross income and still fall into the 15% tax bracket, making them eligible for the 0% tax rate on dividends and long-term gains.
“For example, our clients include a retired couple who receive income from their portfolio and from Social Security,” Gretzschel says. “They had been holding onto a large appreciated stock position they inherited years ago.”
Many clients with large positions in one stock avoid selling and repositioning in order to avoid paying tax on their gains, but a concentrated position may be risky, exposing investors to weakness in that one stock, she says.
This couple’s taxable income falls into the lower tax brackets, Gretzschel says.
“They did not understand that they had an opportunity to diversify and have a portion of their gains taxed at 0%,” she says. “We helped them create a plan to gradually sell and reposition their stock while taking advantage of the tax-free rate on long-term capital gains.”
PROCEED WITH CAUTION
Paying 0% in tax may sound great, but advisors should tread with care, says Judith Colvin,
senior vice president of wealth management and a wealth advisor at UBS Financial Services in Menlo Park, Calif.
“Minimizing projected taxes is an important and embraced objective,” she says.
“Taking taxes into account is always smart. However, letting taxes govern investment decisions is not smart -- I find it important to point out several traps that may be worthy to note when striving for zero in the case of an envisioned tax bracket,” Colvin says.
Taking projected distributions from all retirement plans into account is inherent in the planning process, she says.
“The timing of distributions and anticipating clients' tax brackets at the time of withdrawals is key,” Colvin says. “The strategies can be great, but the details are imperative.”
Advisors should communicate with a client’s tax advisor to make sure that retirement plan distributions won’t disrupt a 0% tax tactic.
Donald Jay Korn is a New York-based financial writer who contributes to On Wall Street and Financial Planning.
This story is part of a 30-day series on retirement planning strategies.