Reached FIRE Yet? Here’s a Way to Earn Tax-Free Income

FIRE is the ultimate goal for many aggressive savers who want more control over the type of life they live. The game plan is to rack up enough savings and investments during your working years to achieve what FIRE stands for: “Financial Independence, Retire Early.”

If you’ve already hit your FIRE goals or are close to your target, it’s a great time to start thinking about earning income without lifting a finger. With dividend-paying stocks, this dream can be your reality in the next 90 days. We’ll break down a lesser-known strategy to help you receive a stash of tax-free income after you reach FIRE.

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Got dividends? Build your income machine now

If you haven’t started thinking about life after FIRE, now is a good time to create a game plan. You can build your portfolio up right now so you can potentially have enough income to fund your lifestyle without touching your investments. Dividend income stocks make this all possible.

Dividends are an extra stream of income that you can collect from your favorite companies. In exchange for your loyalty as an investor, companies are willing to give you cash rewards every month or quarter. This income can flow into your account for the rest of your life if the company’s board of directors continue to declare dividends.

Don’t forget about the power of a taxable brokerage account

If you have a tax-advantaged retirement account, you typically don’t have to worry about taxes until you touch the money in your account. In most cases, you may be waiting decades until you’re eligible to withdraw funds without taxes or penalties. If you have a Roth IRA, you won’t be able to withdraw your earnings until you’ve reached 59 1/2. That doesn’t help you much if you reach FIRE in your 20s, 30s, or 40s.

A taxable brokerage account can help you out until you’re able to tap into your retirement stash. There are no restrictions on when you can withdraw the money. You’ll just have to pay short-term or long-term capital gains rates based on the length of time you held on to your stock.

Let’s say you hold on to your stock for a year or less before selling. You’ll be subject to short-term capital gains rates, which can climb as high as 37%. But those short-term capital gains rates won’t even apply to you if you are investing for the long term. If you are a patient long-term investor, you can earn preferential tax rates in your brokerage account that will make your FIRE lifestyle more rewarding.

Qualified dividends are key to your success

If you’re looking for the best dividend tax rates, you have to make sure your dividends are considered qualified. This is the secret to unlocking the 0%, 15%, and 20% qualified dividends tax rate.

Here are the income thresholds for 2022.

For Single Filers With Taxable Income of:

For Married Joint Filers With Taxable Income of:

For Head of Households With Taxable Income of:

The Qualified Dividends Tax Rate Is:

$0 to $41,675

$0 to $83,350

$0 to $55,800

0%

$41,676 to $459,750

$83,351 to $517,200

$55,801 to $488,500

15%

Over $459,750

Over $517,200

Over $488,500

20%

Data source: IRS. Calculations by author.

Let’s say you’re married and receive $80,000 in qualified dividend income from your favorite companies for 2022. If that’s the only income you’re bringing in during early retirement, your qualified dividend tax rate would be 0%. This could be a huge victory on your tax return when you reach FIRE.

Although your dividend income can be used however you want, your rewards will multiply if you participate in a dividend reinvestment plan, or DRIP. This allows you to automatically reinvest your dividend income to buy more shares of company stock. This leads to more dividends and can help you increase your dividend income over time.

Retire early with dividends

Being able to retire early while still collecting paychecks from your dividend-paying assets is something to get excited about. If you haven’t started your dividend portfolio, now is a great time to do your research, create your game plan, and select the companies that best align with your goals. You’ll be on your way to living your best life in early retirement without sacrificing your monthly income goals.

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