Capital gains planning in retirement

Long-term capital gains receive different treatment from ordinary income, and the structure creates specific opportunities in retirement that are frequently missed.

The rate structure

Assets held longer than a year and sold at a gain are taxed at long-term capital gains rates, which are lower than ordinary income rates.

The rates are tiered by taxable income, and the lowest tier is zero per cent.

Qualified dividends receive the same treatment.

Assets held a year or less are taxed as ordinary income, which is why holding period matters.

An additional tax on net investment income applies above certain income levels, which effectively adds to the rate for higher earners.

The zero per cent opportunity

The feature most worth planning around.

At lower taxable income levels, long-term gains are taxed at nothing.

Someone in the early retirement years, before Social Security and required distributions begin, may have very low taxable income and therefore substantial room in this bracket.

Realising gains up to that limit and immediately repurchasing the same holding resets the cost basis higher at no tax cost.

There is no wash sale rule for gains, so the repurchase can be immediate. The wash sale rule applies only to losses.

Done annually across several years, this can eliminate a significant amount of embedded gain that would otherwise be taxed later.

The competition for the same space

The complication.

Roth conversions also use up the low-income window, and every dollar of conversion income reduces the room available for tax-free gains.

The two cannot both be maximised in the same year, which means deciding which produces more value.

The general considerations: conversions are more valuable where large tax-deferred balances will produce high future required distributions; gain harvesting is more valuable where taxable holdings carry large embedded gains that will need to be realised.

Where assets are expected to pass to heirs, the step-up in basis argues for conversions over gain harvesting, since the gains may never be taxed.

Loss harvesting

The other side.

Realised losses offset realised gains without limit, and a limited amount can be deducted against ordinary income annually, with the remainder carried forward indefinitely.

A stock of carried-forward losses is genuinely valuable, since it allows future gains to be realised without tax — useful for rebalancing a concentrated position or funding a large expense.

The wash sale rule requires avoiding repurchase of a substantially identical security within a defined window either side of the sale, and it applies across all accounts including retirement accounts.

The standard approach is to substitute a similar but distinct fund, maintaining market exposure while realising the loss.

The basis step-up

A significant feature of current rules.

Assets held at death generally receive a basis adjustment to market value, which eliminates tax on the unrealised gain for heirs.

This has a direct planning implication: highly appreciated assets are among the most efficient things to leave to heirs, and depleting them during retirement while preserving assets that would not receive the adjustment may produce a worse family outcome.

It also argues for donating appreciated assets to charity rather than selling them, since both the deduction and the avoided gain are captured.

Practical points

Specify lots when selling. Selling specific tax lots rather than accepting a default method allows control over how much gain is realised.

This must generally be specified at the time of sale rather than afterwards.

Watch fund distributions. Mutual funds can distribute capital gains even in a year when the fund fell, producing taxable income with no corresponding benefit.

Keep basis records for older holdings, transferred accounts and inherited assets. Missing documentation can result in the entire proceeds being treated as gain.

Check the interaction with other thresholds, since realising gains raises income for purposes of Social Security taxation, Medicare premiums and health insurance subsidies.

General information only, not tax advice. Rates and thresholds change annually — consult a qualified tax professional about your own situation.