Mapping the Capital Gains Bump Zone
When you retire I bet you are going to have multiple sources of income right?
You will probably have distributions from an IRA or 401k, interest on your savings, wages from a part-time job and maybe even a monthly check from a tasty traditional pension plan from a previous employer. On top of that to fuel your wild retiree parties you’ll no doubt disinvest some of your hard-earned post-tax savings from your friendly brokerage account.
And that is where the fun starts.
In this article I am going to extend some of the research that Michael Kitces provided in a recent article [Navigating the capital gains bump zone: When ordinary income crowds out favorable capital gains rates] and give a complete picture of the so-called Capital Gains Bump Zones. If you are familiar with Bump Zones then you may want to skip ahead.
Before we begin please make sure you read and comply with the important disclosure.
Capital Gains Taxes
Let’s start with a quick refresher.
When you take a disinvestment from your post-tax savings the IRS wants to make sure they have not missed any taxable opportunities. Given you paid tax on the initial contributions then those are not taxed again when you make a withdrawal, but any investment gains are ‘new’ money and the IRS wants a piece. However, capital gains are not taxed with income tax rates, but instead with a special tier of rates that step from 0% to 15% and then finally to 20%.
Your regular income items are taxed in line with the income tax tiers that are currently 10% / 12% / 22% / 24% / 32% / 35% / 37%.
Note that there are some special rules about short-term and long-term capital gains. But I’m not here to give you a lesson on this, and there are any number of resources that can give you the low-down on capital gains. This article is only going to consider long-term gains so don’t darken my door with short-term gains – you will not be welcome.
Wouldn’t it be crazy simple if income was taxed at income tax rates and capital gains were taxed at capital gains rates? Well they are, but that would have been too simple for the tax code so they introduced some really complex interplay in calculating which of the tiers to use.
Filling The Buckets
I’m sure you understand how to calculate income tax. You start with the lowest bucket at 10% and when that is filled with income you then move to the next bucket of 12% and so on.
Example: suppose you are a married couple filing jointly with a taxable income of $50,000. Your first $19,400 is taxed at 10% and the remainder of $30,600 is taxed at 12%. Easy huh?
The issue comes when you add on capital gains on top of income. I looked everywhere for a description of how to calculate capital gains and could only find it in one place – an article by Michael Kitces. There are numerous articles about capital gains and describing the marginal rates but nothing on how to actually calculate the tax paid. I guess people thought it was just a mechanical procedure and if tax software programmers know how to do it then we’re all good.
However, the Kitces article raises a fascinating issue he calls the “Bump Zones”. These are income levels where you experience an unexpectedly high marginal tax rate. For example a married couple with a taxable income of $60k could experience marginal rates of 27%!
Before we dive into Bump Zones let’s review the different taxation buckets.
Taxation Buckets
The income tax rates are straightforward, and I’ve shown below the individual and married filing jointly rates. Next to it I have shown the long-term capital gains tax rates which have their own tier system. One complication is that – oh what am I saying? Only one complication? This has complications stacked upon complication… But I’m going to follow Kitces and incorporate the 3.8% Medicare surtax on investment gains for high-earners. This kicks in at $200k of AGI for individuals and $250k of AGI for married couples.
This is why you see the 18.8% and 23.8% bands below. Note that I have also subtracted the standard deduction from these AGI numbers in the table below. This is an approximation and if you don’t like it you’ll have to sue me, because my head was ready to explode at this point.

Let’s get into bump zones!
Bump Zones
You can read his article for the considerable detail but it’s best described with a few examples.
First you need to know the key fact that capital gains are only considered when all your ordinary income has been used up in the buckets. At this point your capital gains start filling up their marginal tax buckets. This was a key point I had not been aware of and to some extent really blunts the free-lunch of the 0% capital gains bucket. For a married couple filing jointly you are allowed $78,750 of capital gains tax free! Whoo-hoo!
But not so fast!
First you need to tax your normal income before you are allowed to tax your capital gains.
So if you had precisely $78,750 of taxable income then you have filled that bucket and any resulting capital gains fall into the 15% zone. Boooo! – no tax free capital gains for you!
Let’s look at an example.
Example: a married couple has $50,000 of income and $30,000 of long-term capital gains. We first fill up the 10% and 12% income tax buckets and then start to fill the capital gains bucket. We can enjoy placing most of the capital gains in the 0% bucket with some overflow into 15%.
As you might expect I could not resist hand-crafting a spreadsheet to calculate this stuff. Kitces has some fancy ‘waterfall’ charts but I don’t have the resources of the Kitces empire and so precious readers you are stuck with this output. But don’t worry! I’ve got some eye-candy later in the post so stick around!

You can see above that $1,250 of capital gains fall into the 15% band and the total tax liability is $5,800.
Now let’s ramp up the income to $60,000 and keep the LTCG constant at $30,00 we see the following.

That extra $10,000 of income is attracting an income tax rate of 12% but our tax liability has risen $2,700 which is a 27% marginal rate on the additional $10k.
Holy smokes, what’s going on?!
The $10k income has pushed $10k of the capital gains from the 0% bucket into the 15% bucket. So not only are we paying 12% income tax but an additional 15% capital gains, for a total marginal rate of 27%.
This is what Kitces has termed a “Bump”. It’s an unexpectedly high marginal rate resulting from income ‘crowding-out’ the lower buckets and forcing capital gains into higher brackets.
Kitces then went on to plot the following that vividly shows three distinct Bump Zones for a married couple with $20k of long term capital gains.

It’s a pretty complex picture, but to me it just seemed a bit too… I dunno… one-dimensional. There are two variables at play here – income and capital gains. How does this look if we vary the capital gains amount?
Before we finish this section, let’s show the Bump zones by adding a $50,000 long term capital gain to the above picture.

It’s starting to complete the picture but really we need to examine all possible income and capital gains combinations.
Mapping the Bump Zones
I then wrote a funky macro for my spreadsheet to look at all the possible combinations to map out the marginal tax rates. The following output shows the marginal income tax rates for different income/LTCG combinations.

The horizontal axis has taxable income from $0 to $740k and the vertical axis has capital gains from $0 to $100k.
You can see three distinct Bump Zones in the chart above corresponding to the peaks in the previous line charts of 27%, 27.8% and 40%.
The two lines in the line-chart above for capital gains of $20k and $50k correspond to taking two horizontal slices through this chart as illustrated below.

You can see that these two horizontal slices pass straight through the three Bump Zones.
These 2D charts map out the Bump Zones in greater detail and show precisely what combinations of income and capital gains results in an unexpectedly high marginal income tax rate.
More Detail
Those figures above are a bit hard to read so let’s zoom in on an area to show some greater detail. The figure on the right shows taxable income up to $100k and Capital Gains up to $100k.

The first bump zone is clearly visible in red and if you trace a horizontal line along $20k capital gains you can see it goes directly through the red bump zone for two squares. This is the Kitces example.
Note that for greater capital gains than $20k the bump zone would last longer.
Potential Remediation
Kitces commented that in many ways the bump zones are what they are – a region with larger than normal marginal income tax rates resulting simply from income forcing capital gains into higher taxation bands. However with the full 2D picture this gives a more complete way to picture where you are in the zone and the most efficient way to escape.
Take a look at the chart below where I have highlighted two cells.

One has an income of $70k and LTGC of $70k and the other has income of $40k and LTGC of $40k. Both income/capital gains combinations are in the bump zone, albeit on the edge.
Incidentally this is the stealth power of the bump zone – you would not have guessed from these income figures a marginal rate this high. The marginal rate for $70k or $40k income is 12% and $70k or $40k of LTGC is 0% [married filing jointly]. However the real marginal income rate, resulting from the bump zone, is 27%!
For the 70/70 couple there is not much they can do. Changing their capital gains will have no impact so there seems no option to avoid the high marginal rate on any additional income.
However looking at the 40/40 couple you can see that reducing capital gains will bring the couple out of the bump zone and dramatically reduce the marginal rate for additional income. This however requires flexibility in not only the amount of income the couple receives that year, but flexibility in the relative sources of the income.
Before retirement it is unlikely you would have much flexibility over the amount and sources of your income. Most of your income will probably be from wages where you simply can’t ask your employer to dial-up or dial-down your pay to accommodate your arcane tax gyrations.
However after retirement you may have some discretion to take an IRA distribution, or to increase the tax base of any capital gains, or to perform a partial Roth conversion. These are all legitimate tax timing and optimization strategies that can give you some control over where to recognize income in any given year. To escape the bump zone our 40/40 couple would have to decrease capital gains, and only permit additional taxable income that is of a lower amount. So an escape route could be to reduce capital gains to $20k and increase income by $10k to $50k. But that’s a net decrease in income that might be impossible to swallow. It all really depends on your own circumstances in any given year.

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The way I solved this through the deployment of a cash pile. Cap gains consist of gains and you have to change your thinking on maximizing gains,to a state of maximizing relative gains which takes taxes into account. I’m using the cash to live on while I Roth convert. TIRA’s I am only partially converting because it’s a pay me now pay me later kind of game. Once converted gains in the Roth happen unmolested. By partial conversion to about 214K/yr I miss some of those bumps. I have particular goals in my account asset mix. I want Roth but I want Roth conversion to occur with maximum efficiency so I settled on converting about 3/4 of my TIRA. That gets a large part of future growth into tax free. I leave some TIRA in low return predictable “bond” like equities (3% return) which will RMD a predictable yearly income and treat that as an quasi inflation adjusted annuity. The optimum RMD annuity is about 600K which throws off steady money with minimal taxes. At RMD I also take SS for 2 streams of ordinary income and it’s those streams that determine cap gain liability. If the tippy top of MFJ is about 104k including deductions my taxable ordinary with a 600K TIRA comes in about 6000/mo with a predicable expansion to allow for bracket creep due to COL A etc. That gives me probability a decade of tax stability before I creep out to 22% I have post tax money which I can use to supplement my income so how that comes out is important to the tax bill. I will also have Roth available for money that won’t screw up the tax picture.
It’s hard to optimize beyond 15 years but by controlling growth in the ordinary income stream and having Roth and post tax available to supplement in proper aliquots you can avoid getting creamed by the bumps. If all else fails I also have tax loss harvest hanging around just in case. The real key is understanding cash flow and those tax consequences.
My point was having my income diversified across different asset classes with different tax treatment (Roth. TIRA, SS, Post tax brokerage. Cash) and different rates of return allows you to more finely tune what needs tuning
I like how you are parsing out your return streams, not only by tax treatment, but also by investment strategy. You should write a blog post on this, I think it’s begging a nice graphic to explain the different parts and what part they play in your retirement security.
With me I have yet to define it as thoroughly as you. But I will have a couple of DB pensions in the mix some of which will have COLA. So I can imagine having a similar setup to you.
My blog is poorly indexed but I have written a lot on optimization of pend down. You should go spend some time there. It turns out optimizing spend down with minimization of taxes takes 5 years minimum to plan and implement successfully. Roth conversion unloads part of the ever increasing tax load you owe and it must be viewed that that money already belongs to uncle Sam it’s the cost of the balleyhooed “Max out your pretax” maxim in accumulation. $1000 in your TIRA account at retirement ill become will become 13000 if left for 30 years unspent, but RMD forces spending and so only way to control that is unload that 1000 from the TIRA and stash it somewhere with no taxes. Simple enough till you realize the tax code is progressive and so moving 1000 dollars may cost you 0% because of the write off, but moving 50K may cost $2500 (20%) and moving 500k will cost 117000 or 23.4 cents on the dollar and it just keeps going up till it asymptotes at the top marginal rate . After that you can convert as much as you like in a linear percentage plus surtaxes. So if you own a 2M TIRA your best long term tax move is to convert 2M, If you do it in one year it will cost 669K 33.45% in taxes. If you do it in 5 years 400K/yr it will cost 414,000 total taxes. 10 years 301950 in taxes will need to be paid
After much deliberation I concluded converting a little less than 250K /yr (not top of the 24%) was a pretty sweet spot. It avoids the surtaxes is slightly less progressive than 314K so you can pile in your money pretty cheaply and you hold control of the amount converted not the government till conversion is complete. How you fund the Roth matters since movement of the riskiest assets first is more efficient than moving less risky assets. In working out that timing I figured out the government really does soak the rich and takes it easy on the middle class, so rather than do 100% conversion I took out enough smack dab myself in the middle class and left some money in the TIRA at a lower growth which streams a middle class income with predictable taxes slightly tax advantaged through SS. Not converting every last cent saved some additional taxes right now, but due later and low risk assets doesn’t grow you out of the middle class into upper middle class very quickly. If I had more aggressive growth the RMD would force me into the 22% bracket and 15% cap gain bracket much sooner. Having money is Roth. Post tax, and cash gives control over my wants and needs and doesn’t kick the tax bear. It’s really a pretty complex problem in optimization. I pay for my life though selling a wad of stock and applying some tax loss harvest to the cap gain. I converted about 600K of stock into cash this way and it gave me the freedom to do the optimization with no worry about market gyration. In the end the entire portfolio will still be a 8% return 10% moderate risk portfolio but the risk of the cash flow is nicely separated from the risk of the portfolio. So far my SOR has outperformed compared to my cost of living and with each passing year it becomes harder to run out of money and the projections are 99% success on the Monte Carlo at age 92.
One other fly in the ointment occurs when a spouse dies, the tax treatment of the remaining spouse gets hosed and my kick the survivor up 2 brackets. Coverage for that can be built into the plan as well.