Ideal_Passive_Income
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai and in this episode I want to talk about taxes,
00:00:05.200 | short-term and long-term capital gains, tax rates for 2023, but more importantly, what should be the
00:00:13.600 | ideal passive income target we should all strive for as singles or as married couples filing
00:00:23.200 | jointly. So taxes obviously are our largest ongoing liability. We can't escape them, we got to pay
00:00:30.400 | them, otherwise we're going to get fined or we might get thrown into jail. Who knows, we got to
00:00:35.040 | pay our taxes, but it's fine because if we pay our taxes we help ensure the continuation of our
00:00:41.920 | society, we help young people, we support old people. It's part of being a citizen, right? We
00:00:48.000 | got to pay, but we don't want to pay too much, otherwise we'll start feeling taken advantage of.
00:00:52.880 | And we might leave the workforce altogether, thereby losing a lot of tax revenue. The
00:00:59.120 | government doesn't want that either, so there has to be some kind of balance. And I've been
00:01:03.360 | thinking about this trade-off between time and making money for a long time now, actually since
00:01:09.680 | 1999 when I started having to get into the office at 5 30 a.m when it was still dark.
00:01:14.560 | And I've been thinking more about it recently since I decided to take things down a notch in 2023
00:01:20.240 | because I'm tired. And this is a great exercise, this podcast and this post that I'll link to in
00:01:26.320 | the show notes is a great exercise into thinking what is the ideal amount of income to make and
00:01:32.000 | what is the best composition of your income between ordinary income, active income, and
00:01:38.560 | passive income or hopefully long-term capital gains. So let me first talk to y'all single
00:01:44.800 | individuals. For 2023, if you're single, the largest tax spread difference between short-term
00:01:52.720 | and long-term is if you make between $231,251 to $578,125 in taxable income. So in other words,
00:02:04.480 | if you have active income between that range, you're paying a 35% marginal income tax rate,
00:02:11.440 | a federal, right? But if you have that income in terms of long-term capital gains,
00:02:17.200 | you know, qualified dividends, long-term asset sales like stocks or real estate,
00:02:22.240 | you only have to pay a 15% rate. That's pretty good. So that is the largest spread 35% minus
00:02:29.840 | a 15% tax rate. That's a 20% spread everywhere else underneath or above the spread is not as
00:02:36.800 | great. So this is something to think about in terms of how much in long-term capital gains,
00:02:44.080 | or how much in passive investment income you want to make. It's a target amount. Obviously,
00:02:50.160 | it's a very large amount. So if we use a 4% rate of return, you would require about 5.8 to $14.4
00:02:59.600 | million to generate $231,000 to $578,000 in long-term capital gains, or passive investment
00:03:08.960 | income. Now, obviously, most of us will not be able to get there. But it's just a target. It's
00:03:14.320 | just something to think about. And here's another very important item. You can earn as a single
00:03:20.480 | individual up to $44,625 in long-term capital gains without having to pay any taxes. So you
00:03:29.680 | have a 0% tax rate. Now, that's only possible if you have zero ordinary income. Most of us have
00:03:37.760 | ordinary income because we do work, we consult, you know, we type on a blog, and actually,
00:03:43.200 | I don't make any income from this podcast. So income on this podcast doesn't count. And I know
00:03:47.760 | there's some confusion on how to calculate long-term capital gains taxes if you have ordinary
00:03:54.240 | income. So in the show notes, I have written another post about various examples to see
00:04:00.400 | what your tax liability will be. So you can't make, let's say, $10 million a year in ordinary
00:04:06.800 | income. So yeah, you'll pay the 37% top marginal income tax rate. And then if you have, let's say,
00:04:11.760 | $40,000 in long-term capital gains, you still have to pay a long-term capital gains tax rate
00:04:19.840 | equal to 20%. It's not 0% because the IRS wants its money. So in other words, you have to look
00:04:26.000 | at your total income. And if your total income is crossing these various long-term capital gains tax
00:04:32.160 | rate thresholds, then you have to pay that tax accordingly. And I'll talk about some examples
00:04:38.240 | in later on in this podcast episode. All right, so let's move on to married filing jointly.
00:04:44.640 | What is the most tax-efficient passive income amount to make for married couples? To find out,
00:04:51.280 | let's look at the income range where the difference between short-term and long-term
00:04:57.840 | tax rates is the largest. So that income range is $462,501 to $693,750 in 2023 for married couples
00:05:10.080 | filing jointly. The tax rate difference is also 20%. We are talking about a 35% ordinary marginal
00:05:18.400 | federal income tax rate and a 15% long-term capital gains tax rate. Therefore, you would need
00:05:26.640 | at a 4% rate of return about $11.6 million to $17.4 million in invested capital to generate
00:05:36.560 | $462,501 to $693,750 in passive investment income or long-term capital gains. Now again,
00:05:46.560 | this is just an exercise. If you're trying to figure out what is the ideal amount of passive
00:05:52.000 | income to make, be aware of the net investment income tax which is 3.8%. It applies to whichever
00:05:58.800 | is smaller, your net investment income or the amount by which your modified adjusted gross
00:06:04.000 | income exceeds the amounts listed which are $250,000 for married couples filing jointly
00:06:11.120 | or $200,000 for singles. And again, look at the post, read the post to get some clarification
00:06:17.440 | on how that tax liability is calculated. But let me share one example of how long-term capital gains
00:06:24.240 | taxes calculated when you have ordinary income. So let's say you bought ABC stock on March 1st,
00:06:31.200 | 2010 for $10,000 and you sold it more than a year later for $20,000. So you've got $10,000
00:06:37.840 | in capital gains. Let's say you're single and your income is $65,000. Well, you would be in the 15%
00:06:46.480 | capital gains tax bracket. Why is this? Why is it not 0% capital gains tax bracket since you only had
00:06:55.040 | $10,000 in long-term capital gains? Well, the reason why is because you have $65,000 in ordinary
00:07:03.120 | income and that's above the threshold of $44,625 to pay 0% long-term capital gains tax. So you
00:07:16.080 | had $65,000 in ordinary income and then you had another $10,000 in long-term capital gains.
00:07:24.080 | So you're at $75,000. So $65,000, you pay taxes based on the various marginal federal income tax
00:07:32.240 | bracket rates. And then since you're up over that threshold of $44,625, you are then going to pay a
00:07:42.560 | 15% long-term capital gains tax rate on the $10,000. So $1,500. So how are you ever going to
00:07:50.480 | pay 0% long-term capital gains tax rate? Well, here's another example. Financial Samurai reader
00:07:57.600 | Jeff earns $40,000 in ordinary income. He pays 10% on the first 11,000 in income and 12% on the
00:08:07.040 | income he earns beyond that up to $44,725. So his total tax liability is $4,580. If Jeff sells an
00:08:18.320 | asset that produced a short-term capital gain of 2000, then his tax liability rises by another $240
00:08:26.240 | because that 2000 you multiply that by 12%. This is short-term capital gains, you hold it for less
00:08:34.160 | than a year. So it's ordinary, it's taxed as ordinary income. But if Jeff waits one year
00:08:40.480 | and a day to sell, then he pays 0% on the capital gains. Why? Because total income is $40,000 from
00:08:46.880 | his day job plus $2,000 in capital gains. So that's $42,000, which is below the $44,625
00:08:56.960 | threshold for single people to pay 0% long-term capital gains tax. So I hope this is clear,
00:09:04.560 | because it was confusing to me in the past. And many readers have been confused before,
00:09:10.400 | and you might be confused right now. But listen to it again, or click over to the post to read
00:09:15.680 | the examples. It's very important to figure out what is the ideal amount of money you want to
00:09:21.520 | make. Alright, so let's say you want to make more than $44,625 for singles and $89,250 for married
00:09:30.400 | couples. Again, these are the two long-term capital gains tax thresholds where you pay 0%
00:09:36.800 | capital gains tax rate. So let's say you want to make more. Well, for 2023, the standard deduction
00:09:43.760 | increases by $900 to $13,850 for singles and by $1,800 to $27,700 for married couples.
00:09:53.680 | So you would simply find a job or do some freelance work, whatever, where your adjusted
00:10:00.400 | gross income is less than those standard deduction amounts. Because if it's equal to or less,
00:10:08.080 | you don't pay any ordinary federal income tax on those amounts because they're deductions,
00:10:13.360 | right? And then you can earn long-term capital gains or long-term passive income investments,
00:10:21.200 | qualified dividends, and so forth, up to the threshold of $44,625 for singles and $89,250
00:10:31.920 | for married couples. So if you combine the standard deduction amounts with these 0%
00:10:39.360 | long-term capital gains tax thresholds, you get $58,475 for singles and $116,950
00:10:50.480 | for married couples. Can you all live off that type of income? I sure as heck can. If I was single
00:10:58.800 | or if I was a married couple with no mortgage debt, no consumer debt, simple lifestyle,
00:11:03.920 | decent lifestyle if I don't live in San Francisco or any coastal city, not bad. Even with a couple
00:11:10.560 | kids, yeah, $116,950 for a married couple with two kids and no income taxes. Again,
00:11:16.720 | zero, right? That's great because that adjusted for, let's say, a 30% tax rate is kind of like
00:11:23.040 | making, I don't know, $160,000. So how much capital is required to generate the thresholds
00:11:31.680 | for single and married couple where you pay 0% tax, right? The $44,625 and $89,250. Well,
00:11:39.360 | at a 4% rate of return, you need about $1.1 million to $2.2 million. $1.1 million for
00:11:45.920 | individuals, $2.2 million for couples. And I hope when you hear $1.1 million and $2.2 million,
00:11:53.600 | you feel that it's doable. You're inspired to get there. You don't feel like it's such an outlandish
00:12:00.640 | number to get to in your working career that you just give up. Because I admit, I've talked in the
00:12:07.040 | past about needing $300,000 to live a middle-class lifestyle in an expensive coastal city with kids.
00:12:11.920 | I've talked about, yeah, $5 million. That's kind of like the ideal net worth figure that y'all have
00:12:20.000 | voted on over 10,000 votes that said that's the ideal net worth figure to have before retirement.
00:12:26.160 | And I've even talked about $10 million, right? So the higher these numbers go, I'm afraid some of
00:12:32.080 | you might be demotivated. You might think, why bother? Why care? But as we have just discussed,
00:12:38.400 | you can get to $1.1 to $2.2 million and live an amazingly comfortable lifestyle without having
00:12:47.600 | to pay any capital gains tax. And let's say you're making these amounts. You then have the ability
00:12:56.640 | to go do work, take active income on things you really care about, that are meaningful to you,
00:13:03.840 | that you just enjoy. You can make $5,000, $10,000, $20,000, $30,000, whatever. It doesn't
00:13:09.440 | have to be about the money. It's actually not about the money. It's about doing the things
00:13:12.960 | that you enjoy that are meaningful to you. And if you do that, you're going to feel a tremendous
00:13:18.160 | amount of purpose. Your heart will be filled with joy, or at least more joy. And you'll have
00:13:24.960 | a better time overall in your life. I remember when I first started working,
00:13:28.960 | I was feeling overwhelmed because I was working with people who had windfalls of tens of millions.
00:13:36.000 | And you read the news, just like now, social media, you hear about people making a billion dollars,
00:13:41.520 | they have a hundred billion. It's just, it's so daunting and crazy. So I want to dial this
00:13:46.080 | kind of investing FOMO, this anxiety back a little and say, look, 1.1 to 2.2 million,
00:13:53.040 | if you're married, is good enough to lead a very comfortable and happy life. And yes,
00:13:58.240 | some of you will say, well, it's still 1.1 to 2.2 million. Yes, I know. But it's much more digestible
00:14:04.720 | than thinking about all these other crazy numbers out there on the internet and in the news.
00:14:09.680 | I firmly believe the majority of you, maybe it's 51%, or maybe it's 80%. The majority of you
00:14:17.920 | financial samurai readers and listeners will become millionaires in your lifetime. And this
00:14:23.280 | is a book and topic I want to write about for my next book. So thanks so much for listening. I hope
00:14:28.880 | you're more inspired by this podcast. And I hope it helps you think about ways to earn and spend
00:14:34.080 | your time in a different manner, in a more efficient manner. And if you enjoyed this episode,
00:14:39.520 | I'd love a positive five star review with some commentary. And if you want to support my work,
00:14:44.320 | please check out Buy This, Not That, my Wall Street Journal bestselling book at
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