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The two certainties in life are death and taxes, and some investors prefer to ignore them both—usually to their own detriment.
Capital gains and federal income tax are taxes that investors should be aware of. Understanding the difference between these two taxes and how they could impact your retirement planning can potentially save you time, money, and frustration in the long term.
What Is Ordinary Federal Income Tax?
Federal income tax is a progressive tax on an individual’s earnings. “Progressive” means the tax rate rises along with your income, while “individual earnings” means federal income tax applies to not only your day job but also to ALL your earnings. This includes your paycheck, income from side jobs, inheritance, and even capital gains from investments.
Since federal income is a progressive tax, a higher income increases the dollar amount of your tax liability and your tax rate.
Because of this, lottery jackpot winners who take their payout in a lump sum typically pay a higher tax rate than those who take a gradual payout. Large amounts of income in a single year are taxed at a higher rate than the same income spread over several years. Whether you’ve won the lottery or are just taking the initial steps of planning for retirement, some people take the deferral approach to reduce tax liability.
What Is Capital Gains Tax?
When you think of capital gains tax, let’s take a real-life scenario that’ll explain the process.
Let’s say John purchased a bitcoin on March 8th, 2020 at a cost of $5,047 (about 13x less than its peak price of $66,196), but if the owner of that inaugural bitcoin never sold it, they wouldn’t have paid a penny of capital gains tax on their 13x gain.
That’s because capital gains are only taxed when they’re realized. In other words, investments (even very successful ones) don’t become income until you realize a profit or loss by selling it.
Since your capital gains contribute toward your income, they’re subject to federal income tax, but with a twist: long-term capital gains (revenue from the sale of an investment you held for longer than one year) are typically taxed at a lower tax rate. On the other hand, short-term capital gains (investments you held for less than a year) are generally taxed at your regular income tax rate.
Since investments are inherently risky, realizing a capital loss is possible. If you sell an asset for less than you bought it for, your capital loss could potentially reduce your taxable income.
How Taxes Could Impact Your Retirement Planning
Unlike death, you can schedule and plan your taxes. The difference between capital gains and federal income tax can significantly impact your retirement planning because it affects not only when you pay, but also how much you could owe.
Tax-Preferential Retirement Accounts
The major benefit of an Individual Retirement Account (IRA) is that it is tax-deferred, meaning investors don’t pay taxes until they withdraw funds, usually in retirement. Because federal income tax is progressive, and most people are in a lower tax bracket during retirement, an IRA allows investors to spread out their income over more years, generally reducing their overall tax liability.
A Roth IRA offers a different tax benefit: instead of deferring taxes, Roth IRAs use after-tax dollars that can grow tax-free. There is no capital gains tax on a Roth IRA because investors pay taxes upfront.
Why an IRA Is Different from a Brokerage Account
Capital gains are taxed as income when you realize a gain, whereas income from an IRA is only taxed as you make withdrawals.
You realize a capital gain or loss any time you exchange an asset, so even if you never make a withdrawal from your brokerage, you could still owe capital gains taxes. You might still owe capital gains taxes even if you never saw a single penny—exchanging assets (such as swapping art pieces or trading one cryptocurrency for another) can still have tax implications, even if no U.S. dollars changed hands.
The benefit of an IRA is it allows investors to buy and sell assets without incurring capital gains taxes.
Invest with iTrustCapital
While brokerages incur capital gains taxes and other IRAs with traditional institutions limit investors to the traditional stock market, iTrustCapital allows investors to buy and sell cryptocurrencies and precious metals like gold and silver in a tax advantaged IRA. Since it’s both a precious metals and crypto account in an IRA, there are no capital gains tax until withdrawal and generally lower federal income tax.
Ready to open a tax-advantaged IRA? Sign up today!
This article is for information purposes only. It does not constitute investment advice in any way. It does not constitute an offer to sell or a solicitation of an offer to buy or sell any cryptocurrency or security or to participate in any investment strategy.
iTrustCapital is a cryptocurrency IRA software platform. It is not an exchange, funding portal, custodian, trust company, licensed broker, dealer, broker-dealer, investment advisor, investment manager, or adviser in the United States or elsewhere. iTrustCapital is not affiliated with and does not endorse any particular cryptocurrency, precious metal, or investment strategy.
Cryptocurrencies are a speculative investment with risk of loss. Precious metals are a speculative investment with risk of loss. Cryptocurrency is not legal tender backed by the United States government, nor is it subject to Federal Deposit Insurance Corporation (“FDIC”) insurance or protections. Clients do not receive a choice of custody partner. The self-directed purchase and sale of cryptocurrency through a cryptocurrency IRA have not been endorsed by the IRS or any regulatory agency. Historical performance is no guarantee of future results.
Some taxes and conditions may apply depending on the type of IRA account. Investors assume the risk of all purchase and sale decisions. iTrustCapital makes no guarantee or representation regarding investors’ ability to profit from any transaction or the tax implications of any transaction. iTrustCapital does not provide legal, investment or tax advice. Consult a qualified legal, investment, or tax professional.
iTrustCapital makes no representation or warranty as to the accuracy or completeness of this information and shall not have any liability for any representations (expressed or implied) or omissions from the information contained herein. iTrustCapital disclaims any and all liability to any party for any direct, indirect, implied, punitive, special, incidental or other consequential damages arising directly or indirectly from any use of this information, which is provided as is, without warranties.
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