The Holy Grail of Financial Planning with David McKnight

When David is working with a client, his recommendation is to reach the zero percent tax bracket is by having 5 to 7 streams of tax-free income. These can include Roth IRA’s, Roth 401(k)’s, and L.I.R.P.’s.

David often asks advisors what they think is his favorite. Rarely, will anyone guess the truth is RMD’s (Required Minimum Distributions).

The holy grail of financial planning is any investment that gives you a tax deduction on the front, grows tax-deferred, and you can take it out tax-free.

A Health Savings Account and an IRA or 401(k) that allows you to get a deduction on the front end, grow the money tax-deferred, and then allows you to take a portion of the money out tax-free are two of the few vehicles that tick all the boxes.

You want a balance in your 401(k) that’s low enough that it’s equal to or lower than your standard deduction and doesn’t cause social security taxation. You can use the calculators on davidmcknight.com to figure out your number.

You can also learn your magic number, the amount of money you need to shift each year to achieve your ideal balance.

Your IRA and 401(k) only becomes the holy grail of financial planning if they have the ideal balance. That’s when it becomes tax-deductible on the front end, grow tax-deferred, and the money can be taken out tax-free.

If you have a high deductible health care plan, an HSA is a good idea because when you put money in, you get a deduction, and when you take money for a qualified health care purpose, you get it tax-free.

If your RMD’s are equal to or lower than your standard deduction and don’t cause your social security to be taxed, they become the true holy grail of financial planning.

If somebody says to you that you should convert everything you have to a Roth IRA, you have to think about what is going to happen your standard deduction in retirement. If everything is in the tax-free bucket your standard deduction will essentially be left idle. There is an opportunity cost of moving too much of your money from tax-deferred to tax-free.

If someone recommends a financial plan that only features the L.I.R.P., you need to run the other way. The L.I.R.P. has significant shortfalls and is not the perfect solution, it’s only one piece in the puzzle of getting to the zero percent paradigm.

The holy grail of financial planning is really about establishing the perfect amount to have your tax-deferred bucket. If your advisor can’t tell you what that number is, you’re probably not dealing with a Power of Zero advisor.

The ideal approach to Power of Zero retirement planning is to call on as many of these streams of tax-free income in retirement as possible. Each account and investment is meant to be a solution to a specific situation and they only complete the picture when put together the correct way.

The L.I.R.P. is for addressing the highest risk in retirement, namely a long term care event. In some cases, almost dying can actually be worse than dying by decimating the assets that would normally go to your spouse.

Make sure you have lots of different streams of tax-free income, none of which shows up on the IRS’s radar but all of which contributes to you being in the zero percent tax bracket. Above all make sure you’ve got some money left in your tax-deferred bucket so your standard deduction isn’t left languishing.

Determining the right amount to have in your tax-deferred bucket is critical, in a rising tax rate environment anything above that amount should be shifted over to tax-free.