We’re on track to spend our brokerage money until 59½ – how do we minimize the tax hit on our equity funds?

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Arguably, one of the most essential factors everyone must consider when setting aside money for retirement is taxes. While there is no way to get out of paying taxes at the end of the day, you might be able to get a little creative to avoid the worst-case tax hit. At least, this is the hope for everyone. 

This is the exact scenario one Redditor is currently considering, as seen in a post on r/ChubbyFire. Knowing that they are going to retire in a couple of years, they hope to determine now what needs to be done to avoid a significant tax hit when they turn 59.5 and begin drawing from their brokerage account. 

Almost Time to Retire

The good news is that this Redditor and their spouse are getting ready for retirement in a couple of years. Knowing this, they are trying to get ahead of the curve and make any necessary changes to their current investment structure to become as tax-efficient as possible. 

The current plan is to retire at 55 and live off their brokerage account until they turn 59.5 years of age. At this point, they can stop worrying about any 10% penalty for accessing their 401(k) and IRA accounts. The Redditor indicates there is plenty of money in the brokerage account, but they are trying to minimize any capital gains hit. 

As it stands today, the current investment mix consists of 55% core equity ETF funds, 14% international mutual funds, 13% US core mutual funds, and a miscellaneous set of ETFs that make up the remainder. Instead of worrying about retirement growth like many other posters in Chubby FIRE, this Redditor is solely focused on retirement efficiency, as they call it. 

So, what should the original poster do next? 

Capital Gains and Dividends

One of the Redditors who responded first to this post hit the nail on the head with their response. The first thing the Redditor should do is adjust their strategy. They should focus on maximizing long-term capital gains and then consider dividends as an income strategy.

Regarding long-term capital gains, if the Redditor holds assets for more than one year, this is the first step the Redditor should take when considering withdrawals. The original poster should focus on benefiting from the lower tax rates, depending on how much they are taking out in total.

If the couple is married, which we presume they are, they can take out up to $94,050 and qualify for the 0% long-term capital gains rate. Exceeding this threshold would then result in a 15% or 20% bracket, so this is something to consider, as the tax hit is substantially different between 0% and 20%. 

Another significant consideration is the distinction between qualified dividends and non-qualified dividends. The Redditor should review their qualified dividend holdings and use this money as taxable income. Like long-term capital gains, any dividend withdrawal is taxed at the same rate of 0%, 15%, or 20%.

In fact, there is a strong argument to go big on dividends in this instance and generate income. This could involve examining investments such as QQQI or SPYI, or others that offer strong yields. This could present a good opportunity to review current investments and restructure them to lean heavily on dividend income, especially if it’s in a tax-advantaged IRA account. 

What Is the Planned Spend? 

The one piece of information we need to make a truly detailed decision for this Redditor is, unfortunately, missing. Without knowing their ideal annual spend, it’s hard to say precisely where they should put their money.

However, as one Redditor suggests, if the original poster wants to improve their tax situation, they need to simplify their investments. For this poster, they are going all-in on VTI, which has a 1.25% low yield and a 98% qualified investment, meaning it’s tax-advantaged. This is an excellent idea for simplifying everything, even if the initial sale of assets results in a one-time tax hit. 

The thing is, having a tax hit for one year, while you’re still working, is better to go through now. This means being able to shift the investment strategy completely today and then reap the benefits of the tax advantages later, after retirement. 

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