Money Rehab with Nicole Lapin - WTF are Capital Gains?! (And Three Ways to Master Them)

Episode Date: May 11, 2021

Let’s be real – when someone says “cap gains” we’re all just smiling and nodding. But not for long! Today, Nicole breaks down WTF are capital gains…. and how to make them your best friend. Learn more about your ad-choices at https://www.iheartpodcastnetwork.comSee omnystudio.com/listener for privacy information.

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money is working as hard as you do. So why overcomplicate your money? Keep it simple with Bank of America, your one-stop shop for everything you need today and the goals you're working toward tomorrow. To get started, visit bofa.com slash newprosmedia. That's b-o-f-a dot com slash n-e-w pros p-r-o-s media. bfa.com slash newprosmedia. Hey guys, are you ready for some money rehab? Wall Street has been completely upended by an unlikely player, GameStop. And should I have a 401k? You don't do it? No, I never do. You think the whole world revolves around you and your money.

Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. In my episode on GameStop, remember we talked to a Redditor who made almost two million bucks during the clusterfuck that was GameStop.

Did you catch him mention, though, how much he was paying in taxes? Did you notice it had something to do with capital gains? And now you're thinking, WTF are capital gains? Lucy was. Here's her question. Hey, Nicole. I've been thinking about investing in the market and I'm really excited, but I don't have any experience investing and I'm a little overwhelmed by all the language. One thing I keep hearing is that I need to be mindful of capital gains. Can you explain what that is? So Lucy, I don't need to tell you that taxes are a big fucking deal. They can make a huge difference in making or breaking your wealth. Let's say you made a million bucks last year.

How much would be left over after taxes? If your guess was not a million bucks, after taxes. If your guess was not a million bucks, you are correctamundo. But what is your guess? Maybe 900 grand? Nope. 750 grand? Also a good guess, but wrong go. Let's say you had a 37% tax rate, which is the highest rate in 2020. That would mean you would be left with about $650,000 that doesn't even account for state taxes. If you live in a super tax-aggressive state like New York or California, that number would be way less, close to $500,000. Of course, this is just an example. It isn't necessarily the case for those handful of people who made a million dollars last year. But it does get the point across as to what happens if you ignore the hit taxes can have on your finances. Of course, it's a privilege to pay more taxes because that means you're making more money. And good things

do come from taxpayer dollars. So pay your taxes, boys and girls. Of course, I am not saying to do anything sketchy or illegal. And remember, that's what our auditor friend Sylvia also said. But there are ways to maximize the money you see fully under the letter of the law. I just want to take a moment to shout out financial experts who talk more about skimping on that $5 latte than the things that will make the largest difference in your wealth. I mean, Susie Orman, I love you, sister, but how many lattes can you buy with $500,000 that you just paid in this example? Exactly. So sometimes it's important to focus on the little things like in a relationship or love or friendship, but not in finances. Focus on the big things in finances. That is going to make the biggest difference. So let's dig into what capital gains

are. When you make money on an investment, yay, you will have to pay capital gains taxes. Boo. So what are capital gains? There are two types, short-term and long-term. Both are taxes, but triggered after different periods of time and have different rates. Short-term capital gains, or cap gains as the cool kids on Wall Street say, apply when you sell an investment before a year is up. Today's rates are currently the same as ordinary income tax. So if you're already the highest income earner, and if you're not, you soon will be, that ordinary income tax rate really adds up. Remember from the little pop quiz I gave you, the top federal tax rate is now 37%. And if you combine that with state income taxes, the rate might be 50% or

higher. Long-term capital gains, on the other hand, are taxes that you pay on investments that you hang on to for a year or longer. The tax rate for those gains is much lower than the short-term cap gains as they're taxed at 20% for the highest earners and 0% for the lowest earners. So wherever possible when you do sell investments, try to do so after a year so that you are taxed at a much lower rate. If you happen to lose money on your investments, then the short-term losses can be used to offset short-term gains. The long-term losses can also be used to offset long-term gains. So if you lose $1,000 but you earn $2,500 in the short term, you would be taxed on the difference, $1,500, because the $1,000 offsets

the $2,500. But let's say you also had $1,500 of long-term losses. That could be used against the $2,500, giving you a net, or overall, taxable gain of zero. So here are three ways to master cap gains. First, wherever possible, keep higher cost investments like mutual funds growing inside tax deferred accounts like 401ks or IRAs. So you're letting that compound in a tax-free environment. Number two, try not to have mutual funds outside of vehicles like the ones I just mentioned, because if you're not selling the fund, the folks managing it are a lot, and you're hit with a bill for all that movement even without selling it yourself.

Number three, if you do have any investments, including mutual funds outside of retirement or annuity vehicles, hang on to them for more than a year. Here's a quick example if you're not careful of how fees and taxes can be the enemy of all of your good investment work. Let's say you're making a 7% return on a mutual fund and paying 3% in fees. You now have a return that nets you 4% after said fees. Awesome, right? Well, if you're in the top tax bracket in a state like New Jersey, then you can kiss 50% of that gain goodbye if you sell it before a year's time. That leaves you with a measly 2% of a return after fees and taxes. So they sound super small, like what's 2% here or there, but they actually add up to a lot and they add up to even more when you compound them over time.

Here's today's tip you can take straight to the bank. The more you lower your rate of return, the longer it will take to double your money. So do everything you can to bump up your rate of return and be more thoughtful about your taxes. everything you can to bump up your rate of return and be more thoughtful about your taxes. I am so proud of you, Lucy, for getting into the market. But as you are indexed, funds, and chilling, just make sure to consider capital gains before you sell. Money Rehab is a production of iHeartMedia.

I'm your host, Nicole Lappin. Our producers are Morgan Lavoie and Catherine Law. Money Rehab is edited and engineered by Brandon Dickert with help from Josh Fisher. Executive producers are Mangesh Hatikader and Will Pearson. Huge thanks to the OG Money Rehab supervising producer, Michelle Lanz, for her pre-production and development work. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.