Capital gains tax is levied on profits from selling investments for more than you paid. Long-term gains (held over one year) are taxed at preferential rates of 0–20%, significantly lower than ordinary income rates. Managing when and how you realize gains is a key part of tax-efficient withdrawal planning.
Capital gains tax applies when you sell an investment for more than its purchase price (cost basis). The difference between the sale price and the cost basis is the capital gain, and it's subject to tax. For retirees drawing from taxable brokerage accounts, understanding capital gains taxation is essential for minimizing the tax burden on portfolio withdrawals.
How It Works
Capital gains are classified by holding period:
| Type | Holding Period | Tax Rate (U.S.) |
|---|---|---|
| Short-term | Less than 1 year | Ordinary income rates (10–37%) |
| Long-term | 1 year or more | 0%, 15%, or 20% based on income |
Long-term capital gains brackets (2024, single filer):
| Taxable Income | Long-Term Rate |
|---|---|
| Up to ~$47,000 | 0% |
| $47,000 – $518,000 | 15% |
| Over $518,000 | 20% |
Key concepts for retirees:
- Cost basis: Your original purchase price plus any reinvested dividends. Higher basis = lower taxable gain.
- Tax-loss harvesting: Selling investments at a loss to offset gains, reducing net taxable gains
- Stepped-up basis at death: Heirs inherit investments at current market value, eliminating all accumulated unrealized gains — a powerful estate planning feature
- Wash sale rule: Cannot claim a loss if you repurchase the same investment within 30 days
Why It Matters for Retirement Planning
Capital gains tax affects several retirement decisions:
- Withdrawal order: Selling from taxable accounts triggers capital gains, while withdrawals from tax-deferred accounts are taxed as ordinary income. The relative rates determine which account to draw from.
- Portfolio rebalancing: Selling appreciated assets to rebalance generates taxable gains. Retirees can minimize this by rebalancing through withdrawals or within tax-advantaged accounts.
- 0% bracket opportunity: Retirees with low income can potentially realize long-term gains at a 0% tax rate — effectively "resetting" the cost basis of investments for free.
- Charitable giving: Donating appreciated shares directly to charity avoids capital gains entirely while providing a tax deduction.
In retirement simulations, accounting for capital gains tax on taxable account withdrawals provides more realistic after-tax income projections.
A Practical Example
A retiree needs $40,000 from their taxable brokerage account. The account holds shares purchased for $200,000 now worth $500,000 (60% unrealized gain).
| Withdrawal Method | Amount Sold | Cost Basis | Capital Gain | Tax (15%) | After-Tax Income |
|---|---|---|---|---|---|
| Sell proportionally | $40,000 | $16,000 | $24,000 | $3,600 | $36,400 |
| Sell high-basis shares first | $40,000 | $32,000 | $8,000 | $1,200 | $38,800 |
By specifically selling shares with a higher cost basis (a technique called "specific lot identification"), the retiree saves $2,400 in taxes on a single withdrawal. Over 20 years of withdrawals, this attention to tax-lot management can save tens of thousands.
Compare this with withdrawing the same $40,000 from a Roth account ($0 tax) or a tax-deferred account (~$8,800 tax at 22% ordinary income rate). The optimal source depends on the retiree's total income picture for the year.
Frequently Asked Questions
- What is the difference between short-term and long-term capital gains?
- Short-term capital gains (assets held less than one year) are taxed as ordinary income at rates up to 37%. Long-term capital gains (held over one year) are taxed at preferential rates of 0%, 15%, or 20% depending on taxable income. This difference makes holding period a key consideration for tax-efficient investing.
- Can I avoid capital gains tax in retirement?
- Partially. If your taxable income is low enough, long-term capital gains can fall in the 0% bracket (up to ~$47,000 for single filers in 2024). Roth account withdrawals have no capital gains tax. Tax-loss harvesting can offset gains with losses. And assets held until death receive a stepped-up cost basis, eliminating the gain entirely.
- How does capital gains tax affect portfolio rebalancing?
- Rebalancing in taxable accounts can trigger capital gains tax if you sell appreciated assets. To minimize this, retirees can rebalance by directing withdrawals from over-weighted assets, use new contributions to buy under-weighted assets, or rebalance within tax-deferred and Roth accounts where there are no tax consequences.