Early retirement is one of the only legal tax shelters most Americans will ever experience. When you stop earning a salary and start living off your investments, your taxable income can drop dramatically — creating a window to pay little or no federal income tax.
Here's how to take full advantage of it.
The 0% Capital Gains Bracket
In 2025, the 0% long-term capital gains tax bracket applies to taxable income up to approximately $94,050 for married filing jointly (or $47,025 single). This means if your total income — including capital gains — stays under this threshold, you pay nothing to the federal government on investment profits.
For an early retiree living on $40,000/year in long-term capital gains from a taxable brokerage account, this is potentially $0 in federal capital gains tax.
The Standard Deduction Is Your Friend
The standard deduction in 2025 is $30,000 for married filing jointly. This means the first $30,000 of your ordinary income is tax-free. If you're doing Roth conversions, this is $30,000 of conversion you can do completely tax-free every year.
The Strategy: Stack It All
A well-engineered early retirement tax year looks like this:
- $40,000 in long-term capital gains from taxable brokerage (living expenses)
- $30,000 Roth conversion (ordinary income, but covered by standard deduction)
- Total federal tax: $0
You've funded your lifestyle AND moved $30,000 out of your tax-deferred 401(k) into a Roth IRA, permanently reducing your future Required Minimum Distributions — and you paid nothing.
ACA Subsidies: The Hidden Bonus
The Affordable Care Act subsidies are based on Modified Adjusted Gross Income (MAGI). With careful income engineering, many early retirees qualify for substantial premium tax credits, making health insurance nearly free until Medicare kicks in at 65.
The key is keeping your income above the Medicaid threshold (100% of FPL) while staying below the subsidy cliff. Consult a tax professional to calibrate this precisely — getting it wrong in either direction is expensive.
What to Watch Out For
This strategy requires careful planning. Common mistakes include:
- Forgetting state taxes — several states don't have capital gains preferences
- The Social Security tax torpedo — once you claim SS, up to 85% becomes taxable
- IRMAA surcharges — high income in Medicare years triggers premium surcharges
- Roth conversion timing — the 5-year rule applies per conversion
The bottom line: early retirement tax planning rewards the organized. Download the Bridge Planner to model your own numbers, and consider working with a fee-only FIRE-aware CPA at least once to set up your strategy correctly.