Welcome to the Bowman financial strategies, retirement made simple series. Your host is Erik Bowman, retirement income certified professional and certificate holder of the national social security association.

What is a capital gain? If you own an investment, say it's worth $1,000, and then you sell it and you made a hundred dollars; so, you sold it for $1,100. That $100 in gain is now a capital gain. Whether or not it's going to be subject to one of two types of taxation, depends on the holding period. If it's held for less than one year, when it's sold, it's going to be subject to short term capital gains taxes, which is identical to ordinary income tax. Short term capital gains are taxed like income tax. Long-term capital gain is also considered income. However, it means you held the investment for more than a year when you sold it for that game. And it's subject to its own unique marginal tax bracket system. 

So, if we take a look at this tax bracket system, we can see that it has three tiers. The first one from zero to 80,000 is no tax. The second one from 80,000 to almost a half a million dollars is taxed at 15%. And then over that is going to be taxed at 20% marginal tax rate. 

So, what I'd like to do now is go into an example and let's make it simple by assuming the only income you have in that year that we're going to do this calculation is long-term capital gain income. And let's assume that you have $120,000 of long-term capital gain. Now we're going to try to estimate your federal income tax. Well, the first thing we need to do is to take out the standard deduction of 24,800. That's not subject to any type of taxation. Now from that spot right at zero, which is above the deduction up to $80,000 will not have any taxation because it falls into that first tier of long-term capital gains tax. But once you exceed 80,000, the remaining amount would be subject to 15% capital gains tax for a total of $2,280 of total taxation. 

So, here you can see that compared to ordinary income tax so that there is some benefit to having potentially some capital gains available to you when you're trying to draw your income strategically in retirement so that you can manage those tax brackets. Let's look at a more complicated scenario that probably could be a little more realistic, where we have both IRA distributions that are ordinary income and taxed as such, and then some long-term capital gains represented by the purple in the graph that you're looking at. So, we want to stack those on top of each other. It's very important that the long-term capital gain income always goes on top of the ordinary income. And you'll see, as we go through the example.

So, the first thing we want to do is remove the standard deduction. $24,008 comes off the bottom. And then we want to actually look on the left side of the graph, where we're showing the ordinary income tax brackets and contrast that with the right side of the graph where we have the long-term capital gains tax brackets. So, the first thing we want to do is look at the ordinary income side and we see that the green that represents the ordinary income goes through the first tax bracket of 10%, up to 19,750 of that taxable income, for a tax burden of $1,975. And there's another portion of it that's subject to the 12% tax bracket. Then on top of that, we have the long-term capital gain. So, now we're going to shift our analysis over to the right side of the graph, and we can see that a pretty good portion, over $44,000 of that long-term capital gain is still below the $80,000 threshold and is therefore not subject to any taxation. Now, the bit that actually exceeded that 80,000 threshold, is now going to be subject to 15% taxation, $2,280 the estimated federal tax burden in this case. If you add all of those together, you get a total tax of $6,109. So, what we've just shown though is that having a combination of potential taxable income sources can theoretically give you some strategic opportunity to draw money from sources to manage your income taxes and retirement.

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