Hello everyone, and welcome to the Retirement Planners of America podcast. I am Ken Moraif, the founder and CEO of Retirement Planners of America. Thank you for watching. Hope this podcast finds you healthy, wealthy and wise. What we’re going to talk about in this episode is capital gains taxes and why they are so important. First of all, what are they and how are they different from ordinary income taxes, but then also, why are they so important when you’re designing your retirement plan? Okay? Because reducing your taxes is one of the best ways to have your money last as long as you do, which is what we want to have happen. So we’re going to dive into that. So thank you for watching. I’m going to bring my co-host here, Jeremy, into the picture, and actually, Jeremy, you’re going to interview me.

Yes, indeed. Yeah, that’s great. Yeah, we have the expert truly doing the interviewing.

So I started it, but you’re going to interview. Yes, absolutely. So you’re, for people who are maybe old enough, you’re the Ed McMahon to my Johnny Carson, absolutely.

That’s absolutely—hey, I’ll take that role any day.

Yeah, so one of the things you know that is very important is the whole thing about, you know, capital gains and ordinary income taxes. So go ahead, interview me. I’m ready to be interviewed. I’m psyched. I’m pumped.

What is a capital gain tax? What is a capital gain? What is a capital gain? Let’s start with that.

Okay, so a capital gain is basically you buy something, let’s say for $100, okay, and then it appreciates in value, and now hopefully it’s worth $200. Fancy. And so in that example, you just had a $100 capital gain, gotcha, right? That’s different from ordinary income tax, which is wages and interest and dividends. It’s not on the appreciation of an asset, it’s on the income it’s producing. That’s ordinary income.

Gotcha. Okay, so it is a completely different kind of method of taxing something. Why is it taxed differently than wages? Why is it taxed differently than interest? Like, what’s that difference?

Yeah, there’s a lot of talk I’ve heard about, you know, that capital gains taxes, you know, favor rich people, and we should abolish them. And, you know, we’ve heard that some people pay less tax than their secretary, or something like that. So the capital gains taxes were actually created for two reasons. One is fairness, okay? Because if we had no capital gains tax, then people who have assets—you know, let’s say you buy stocks, that’s what you’re retired now, right? Or you’re a wealthy person, and you buy a bunch of stocks, and all you’re doing is selling your stocks all the time to get the money you need to live on. If there’s no capital gain on that, you pay no tax at all. Yeah. And so what would happen is you’d have a system where everybody would transition over into that side of things, and now the only people paying taxes are the people working, you know, and the people getting interest on stuff. And that wouldn’t be fair. So the first thing was to create a fair system. The other thing also for capital gains—the reason—is to encourage people to invest for the long term, you know, because what creates volatility and uncertainty and disruption in the economy is when there’s a lot of people selling and buying, and you know, it’s happening really fast. That causes a lot of chaos, and it doesn’t create a stable economic environment. So you want to have people, when they invest in things, to be long-term investors. You want them to buy and sit on it for a long time, so that there’s a stability there. And so that’s why we have a difference with long-term investments, which are capital gains, and short-term, which are ordinary income, right?

And you won’t be taxed on it until you sell it.

Yes, that’s correct. And that’s a big advantage of the capital gain. In the example I gave—your stock or your real estate, whatever you bought for $100 and now it’s worth $200—that $100, you owe no tax on it until you sell it, yeah? And so in a way, it kind of locks things up, right? People don’t want to sell that because they don’t want to pay that tax. That is a downside of the capital gain tax, right? Certainly.

Yeah, yeah. It incentivizes holding it, and then also keeps people from wanting to sell it. I don’t know anyone—I’m trying to think off the top, if I know anyone that likes paying taxes—I can’t name anybody.

There’s probably somebody out there who does. Very patriotic, yes. They’re like, I want to help the country. I like paying taxes. Absolutely.

Okay, so we know what a capital gain is. We know how it’s taxed. How do we apply that to actual retirement planning? Can you give me an example of something that is taxed regularly, like wages, things like that, and then something that would be taxed as a capital gain?

Okay, yeah, that’s a very good question. So when it comes to, you know, how somebody who is planning for their retirement, or is already retired—if we look at the investment, the places where they have their money—the taxes are based on where you have your money, right? Okay, so for example, if you have IRAs, and you have 401(k)s, and you have those things, if they are traditional, right? Not the Roth version, but if they’re traditional, then what happens is that every dollar that you take out most likely is going to be taxed at the highest ordinary income tax rate. Because it’s not—they don’t—they’ve designed it in a way where they say, this is not a capital gain, this is income, right? And so if you’re taking money out of the IRA or 401(k), you’re taking income, and therefore you’re taxed at the highest rate. Now, if you have money that is not in an IRA—and we call that a non-IRA…

You fancy that? Pretty creative, succinct.

Yeah. So if you have money in your non-IRAs, then what happens is that those dollars potentially could be taxed at capital gains rates. And the capital gains rates are potentially half of what the ordinary income tax rates are, if you’re in a high enough bracket, right? So there’s a significant arbitrage, if you will—ability to pay a lower tax—if you understand the difference between where your money is, what’s the container that it’s in, versus where it’s not.

Okay, so how do we actually implement that in planning someone’s financial retirement? How do we take advantage of that to get the least taxes paid and the most out of their money?

Yeah, so one of the rules that we like to apply is that you want to defer your ordinary income taxes for as long as possible. Defer, defer, defer. Okay, so when we work with a client, or even a brand new client, what we do is we want to segregate their dollars as IRAs, 401(k)s, those kind of things. But then we want to have all the non-IRAs that are taxed at potentially capital gains rates. So we have them in different columns. We segregate them. Even though, you know, a lot of times people say, well, it’s all my money. Well, it is all your money, you’re right, but it’s different. We have to think of them differently. The government looks at them differently.

They certainly do.

Absolutely, and from a tax standpoint, they are different. Yes. And so our goal is for your money to last as long as you do. And there are several things that can cause that not to happen: inflation, big bad bear markets, and taxes. Okay, so today we’re talking about taxes. So if we can mitigate or reduce our taxes—defer the ordinary income tax for as long as possible—that goes a long way in most cases to having your money last longer.

Yes.

Okay, so what we do when we visit with a brand new client or with a prospective client who now wants to get income from their investments, we want to look at the order of events. You know, where are we going to get it from first? So with IRAs and those accounts, there are what are called required minimum distributions. So the required minimum distributions are there because of this dynamic that I’m talking about. Yes, people potentially could defer the money they have in their IRAs and all that forever. If there was no required minimum distribution. So what they don’t want you to do is to do what we’re saying. So what they want you to do is take it out and pay the highest tax.

Absolutely.

Okay, so when you get to the required minimum distribution age, you are now forced to take out a required minimum distribution. You don’t have to take it all out, but you have to take a minimum, right? And there’s a formula for that, which we talk about in other podcasts. But for purposes of our conversation, that’s going to be when you are forced. So what we want to do is not take anything out of those accounts until we are forced.

Until we have to.

Now, we may have to because we need it to live on.

Yes.

Which is okay if that happens.

Absolutely.

But if we don’t need it to live on—if we have non-IRA money that we can live on instead—we want to start with that.

Yes.

Why? Well, let me use the example that I was using before. So let’s say that you have $100 in non-IRA money, and over time, it’s grown to be $200 worth of non-IRA money. And you can draw from that to live on, you know, and you don’t need to touch the money that’s in your IRAs and 401(k)s for the time being, right? So when you take that money, the way they tax it is that $100 of capital gain is first. So you had $200, and let’s say you’re taking $10 a year out—I’m using small numbers—but you’re taking $10 a year out, so you’re going to use up that $100 of gain, right? So you’ll pay capital gains tax on it. But then what happens is—and that’s the beauty of this strategy—is that now, if you start spending the $100 that you originally invested, there’s no tax on that, because you already paid tax on it before you invested it. So that money comes back to you tax-free. So now, you’re spending your own money tax-free, and that’s really great.

That’s incredible. Yeah.

And then, only once you’ve used up all the non-IRA money do you then go to the IRA side. And the longer you can defer tapping into that, the longer the compounding can happen without taxation, and you delay paying the highest tax rate. So it’s a way to essentially have your cake and eat it too.

And who doesn’t like cake?

Who doesn’t? Especially tax-efficient cake.

Yes, tax-efficient cake—our favorite flavor here at Retirement Planners of America.

That’s right. And so, when we look at retirement planning, taxes are a huge part of it. And people don’t realize how much taxes they may be paying unnecessarily. If you don’t have a strategy—if you’re just taking money out willy-nilly—then you could be paying way more in taxes than you need to. And the government’s not going to call you and say, “Hey, by the way, you paid too much tax this year.”

Right. That call’s not coming.

Nope. Not happening. So you need to be proactive. That’s what we do with our clients. That’s what retirement planning is all about. It’s looking ahead and saying, “How do we maximize every dollar you’ve worked so hard to save, and make sure it lasts as long as you do?”

Absolutely.

And taxes are a huge part of that. So again, capital gains—when used properly—are a powerful tool to reduce your tax burden in retirement. You just have to know how to structure your withdrawals to take advantage of it.

That’s great insight. And I know we’ll do more episodes diving into things like Roth conversions, required minimum distributions, all that. But this gives a great overview of how capital gains work and why it matters in retirement planning.

Exactly. And that’s why we do this podcast, to help you be informed, educated, and empowered. If you’d like to learn more about how we can help you plan for retirement and manage your taxes, you can go to our website at rpoa.com. You can schedule a free retirement consultation with one of our retirement planners, and they’ll go through all this with you. No cost or obligation. We want to help as many people as we can.

That’s right. So thanks again for joining us. We hope this has been helpful, and we’ll see you next time on the Retirement Planners of America Podcast.