The Power Of Zero Show

At the time of recording this podcast the results haven’t been certified but it looks like Joe Biden will be the next US president. There are a couple of different outcomes that you need to pay attention to. The first involves him not controlling the Senate. In order to win the Senate Democrats would have to win two seats in a runoff election on Jan 5 but pundits are saying that result is unlikely. If Republicans control the Senate there will be a lot of obstruction for Joe Biden’s agenda. Everything that Joe Biden campaigned on is going to be effectively neutralized and he will probably have to postpone any changes until the midterms two years from now. This means you can expect two years of relative status quo, but if the Democrats do win those Senate seats in the midterm elections or want to press his program, he will likely try to make the most of the opportunity and push through his agenda more aggressively. If you make more than $400,000 per year, you are essentially a marked man or woman. For example, if you live in California you will have to pay a 13.3% State tax, a 39.6% Federal tax, an additional 14% additional Social Security tax for every dollar over the $400,000, and finally a 3.8% for an Obamacare surcharge. This scenario results in 1970s style tax rates where you would be paying 70.7% in taxes. You will also have fewer ways to mitigate that tax and be unable to deduct 401(k) contributions on the margin as well. Joe Biden has proposed considerable changes to the way 401(k) deductions are done so we are going to start to see deductions phasing out for people in the higher income levels. Joe Biden wants to be able to tax you at high marginal tax rates and doesn’t want to give you a lot of recourse in terms of mitigating that tax. If you have significant income, your long term capital gains could become short term gains. If Joe Biden wins the Senate he will have two years to put this into law but in the process will likely upset a lot of people and potentially lose the Senate after the midterms, however this means that for the first two years you better duck and cover if you make $400,000 a year or more. If you make less than $400,000 a year, a Joe Biden presidency is relatively good news for you. Joe Biden plans on letting the tax cuts expire for the people that make $400,000 or more but for those who make less, he plans on making the tax cuts permanent. This could make contribution to your 401(k) a bit more complicated and for those above the $400,000 threshold they will probably want to consider some other options. In terms of the Power of Zero paradigm, it is largely good news if you believe that Joe Biden will make the tax cuts permanent for those who make less than $400,000 per year. We can’t afford to keep tax rates this low and have actually gone beyond the point of no return. We would have to tax 103% for every dollar made over $400,000 just to prevent the deficit from growing. This doesn’t include actually paying off the debt. Unless you believe in Modern Monetary Theory there doesn’t seem to be any other way to solve our problems other than ultimately raising taxes on the middle class. Joe Biden is kicking the can down the road and it’s going to compound our problems over time, but if you’re looking to take advantage of this opportunity before we come face to face with reality, this is a great opportunity to shift money to the tax-free bucket. If Joe Biden wins over the Senate there’s going to be a lot of shock and awe in the first two years of his administration as they push through a number of pieces of legislation that will disproportionately impact people who make more than $400,000 a year. If he doesn’t win the Senate he will bide his time until the midterms to gain the seats he needs to implement this agenda.

Today’s episode covers the last secret to mitigating the two most concerning risks of people planning to retire. People are afraid of running out of money before they run out of life. Traditionally the way you can mitigate that risk is by accumulating a lot of money and restricting your distributions to 3% which gives you a statistical likelihood of not running out of money. The alternative is by guaranteeing your income by way of an annuity. Economists say that the ideal way to guarantee an income stream for life involves giving an insurance company a large lump sum in exchange for a steady stream of income for life. There are a number of shortfalls with that approach including a lack of liquidity and what David refers to as the “Mack Truck Factor”. Single premium immediate annuities do not adjust for inflation which means as inflation goes up your spending power goes down. Insurance companies have recognized a number of benefits of having an annuity as well as attempted to address the shortfalls. The solution they’ve come up with is a fixed indexed annuity. A fixed index annuity gives you liquidity on your dollars and the growth of the money in the account is linked to the upward movement of the market. They also come with death benefit features which do quite a bit to mitigate the issues with traditional annuities. The big mistake that most people make is they implement these annuities in the tax-deferred bucket, exposing themselves to the risk of a rising tax-rate environment. Insurance companies provide options to convert that fixed indexed annuity to a Roth IRA but that comes with its own set of problems. In an attempt to avoid doubling your taxes over time you may end up doubling them in the short term. There is another option known as a piecemeal internal Roth conversion that allows you to convert your annuity over whatever timeframe your financial plan calls for. The piecemeal internal Roth conversion eliminates the two greatest risks to your retirement, tax-rate risk, and longevity risk. When you remove those risks off the table, you also take care of the sequence of return, withdrawal rate risk, and inflation risk. Historically, financial advisors will say you can only mitigate one of those two risks. Either you have liquidity and don’t have to worry about longevity or you cover longevity and have no liquidity. The plan outlined in Tax-Free Income for Life allows you to effectively remove longevity risk, along with all of the risks that get magnified as a result of longevity risk, and tax-rate risk all in the same financial plan. If you’re looking for an advisor to help you navigate all the pitfalls that stand between you and the zero percent tax bracket, as well as mitigate both longevity risk and tax-rate risk you can go to davidmcknight.com to get connected with an Elite Advisor. The Power of Zero and Tax-Free Income for Life are companion volumes essential to your financial plan.

In the previous episode, David explained the surprising benefits of having a guaranteed income stream in retirement via an annuity, including living longer. If there are so many benefits of owning a guaranteed lifetime income annuity, why aren’t more Americans taking advantage of these programs? There are three major barriers that are preventing people from ever entering into the transaction. The first issue that Americans have has to do with liquidity. In order to pull off the annuity deal, you have to give a large lump sum to an insurance company and you can’t undo the transaction. There is a psychological benefit to being able to access your money at a moment’s notice so the act of giving up liquidity is a major barrier for many people. The second problem is the lack of inflation hedge. The typical single premium immediate annuity does not index for inflation and people are afraid the income provided may not be enough to cover their expenses in the future. Some people approach the problem by increasing the lump sum at the beginning but that leads back to the first complaint of lack of liquidity. The third problem is the “Mack Truck Factor”. If you go for a large annuity under the assumption that you will live for a long time but get flattened by a Mack truck a couple of years later, that asset will disappear from your balance sheet. However unlikely the proposition, the potential of making the worst investment ever and losing their kids’ inheritance is a scary scenario for many people. Insurance companies are not blind to these three problems. They’ve created a fixed indexed annuity to try to address these issues and mitigate some of the risks involved. To address liquidity, they allow you to withdraw 10% of that annuity per year. This isn’t full liquidity but basically functions the same way when you think about the 3% Rule. To address inflation, the annuity is placed into a growth account that is linked to the upward movement of a stock market index. You’re not going to hit a homerun in this account but since the goal is to guarantee a stream of income until you die, this fits the bill. The last issue is addressed by a death benefit. If you die up to two years after purchasing an annuity, whatever you don’t spend goes to the next generation including any growth on that money. As great as all that sounds, the last issue is that 99% of fixed indexed annuities get implemented in the tax deferred bucket. There are two major problems with that approach. When you have that annuity in your tax-deferred bucket, it can never be undone, which means you are exposing yourself to tax rate risk. If tax rates rise dramatically in the future you will have a hole in your income and will have to find a way to compensate. The second issue is that taking money out of your tax-deferred bucket, even if it’s from an annuity, counts as provisional income and can lead to the risk of social security taxation. The combination of these two things, tax rate risk and social security taxation, could force you to spend down your stock market portfolio 12 to 15 years faster than you otherwise would have.

This is the first of three podcasts leading up to the release of David’s latest book, Tax-Free Income For Life. According to a number of surveys, the number one risk that retirees are most concerned about is outliving their money. One of the ways to mitigate longevity risk is by having an annuity. There are a number of benefits that come with guaranteed lifetime income annuities, the first of which is retirement predictability. The first benefit of a guaranteed lifetime income annuity is closing the income gap between the amount required above and beyond what is provided for by your social security and government pension. An annuity has the ability to completely mitigate longevity risk. The second benefit is that people who have an annuity that can guarantee their income generally have considerably less anxiety and a higher level of happiness than those that don’t. An annuity won’t bring anxiety-free retirement but it will certainly be much less than those who have to rely on the stock market to achieve their retirement goals. The third benefit may surprise you. With a guaranteed lifetime income annuity, you will likely live longer. Studies show, after adjusting for all other variables, people with annuities tend to live longer than their counterparts who don’t have them. The fourth benefit allows you to skirt around the 3% rule. While the 3% rule should generally work to ensure you never run out of money it tends to be a very expensive proposition. An annuity allows you to mitigate that risk with much less money. This can also free up more money to invest in the stock market. The final benefit is that because of the ability to guarantee your income with less money than you would require otherwise, you can take a greater risk in your stock market portfolio and be more aggressive. If the stock market goes down you are not going to be forced to take money out in a down year since you will have your living expenses guaranteed by your annuity. You will have the luxury of waiting for the stock market to recover in that scenario. Most of the money that you are planning on spending on your discretionary expenses in retirement has not been earned yet when you retire. You must have the ability to stretch your stock market portfolio over a possible 30 year time frame which requires you to take more risk in your investments. When you guarantee your lifetime income, you have a permission slip to take more risk in the stock market. A guaranteed lifetime income annuity also neutralizes two risks that have sent many retiree’s portfolios into a death spiral. Namely sequence of return risk and withdrawal rate risk. This can prevent you from running out of money up to 12 to 15 years earlier than you expect. You don’t have to worry about taking unduly high distributions from your stock market portfolio if your income is provided by a different means like a guaranteed lifetime income annuity.

Joe Biden is coming for your 401(k) and it’s actually worse than David portrayed it in previous episodes of the podcast. Under Joe Biden’s tax proposal he is going to equalize the tax benefits of retirement plans. David breaks down exactly what this means for people in different tax brackets and what the implications of this plan are. In order for Joe Biden’s plan to be tax neutral the rate at which you receive a tax credit is 26%. This essentially means that anyone in a tax bracket under 26% is getting a great deal and anyone in a bracket above the 26% tax bracket is getting a terrible deal. Let’s say you’re in a 39.6% tax bracket and wanted to contribute $20,000 to your traditional 401(k). With the 26% benchmark you would receive a $5200 tax credit and have to pay $2720 in income tax on that contribution. But wait, there’s more. At some point you are going to have to take those dollars out because they haven’t taxed yet. Not only did you pay 13.6% to put the money in, if you’re still in the 39.6% tax bracket when you take the money out you end up paying 53.2% and that still doesn’t count the state tax implications. The math taking place on the tax return happens on a separate line which means the contribution carries down to the state level. Unless state legislatures act, your retirement plan contribution may be fully taxable at the state level when contributed. Since the retirement account is still pre-tax, which means the balance of your retirement account might be fully taxed at the state level upon distribution. The solution is fairly simple. If you find yourself above the 26% tax bracket, the solution is to simply stop contributing to your 401(k) and only contribute to your tax-free bucket. Pay your tax rate today if it’s above 26% and avoid all the extra taxation. You are not going to be able to keep very much of your savings if you’re above the 26% threshold and you contribute money to your 401(k). This proposal has the ability to radically redefine the retirement landscape. If Joe Biden wins the election, this proposal could become a reality.   Mentioned in this Episode: The Biden Tax Plan: Proposed Changes And Year-End Planning Opportunities 

Today’s podcast is based on a recent article penned by Maya MacGuineas titled The Debt is Huge Because Trump Kept His Promises. Maya also appeared in David’s documentary The Tax Train is Coming. Much of what Maya says is that we shouldn’t be surprised by what happened during Trump’s first term since it has been exactly what he campaigned on. The debt that has accumulated has been a result of President Trump’s campaign promises of steep tax cuts and increased spending on both defense and veterans, and crucially, he promised to not make any changes to Social Security and MediCare. We are now paying the price for it. The numbers proposed were so huge that they seemed exaggerated and improbable, in other words, the amount of debt that Trump was looking to accumulate over the course of his first term was astronomical. The Nonpartisan Committee for a Responsible Federal Budget estimated that Trump’s agenda would increase deficits over the next ten years by $4.6 trillion. The numbers at the end of Trump’s first term are even worse due to the extra spending for the Covid-19 lockdown. In Trump’s first three years he approved $3.9 trillion in borrowing just to pay for the tax cuts he introduced. Any good economist will agree that tax cuts are okay if they are paired with a commensurate decrease in spending, the problem is we didn’t do that. While all the other economies in the world are paying down their debts, the US is piling debt upon debt. The deficit has never been so high when coupled with an economy that was going as well as it was prior to 2019. When you add up the additional borrowing that the US made to deal with Covid-19 the impact is immense, and the borrowing is just beginning. The $2 trillion borrowed initially was only the first half of the bridge. Had we been more fiscally responsible prior to Covid-19 we would not be in the same bind. We would be in a better position to handle something like Covid-19 had we not accumulated so much debt prior to it. There are a few things that Trump did not follow through on. The business tax cuts have not paid for themselves. Trickle-down economics is the idea that decreased taxes and increased capital going to corporations leads to an increase in the economy, but that would only happen with a concurrent decrease in spending, which did not happen in this situation. Discretionary spending is a relatively small portion of the budget, roughly 23% of the economy, and while Trump proposed reducing discretionary spending it actually increased by over $700 billion. Part of the problem is that Trump ran on not touching Social Security or Medicare and every year that goes by where we do not reform Social Security or Medicare in some way has an economic cost. Every year that goes by where we fail to address these two programs means the fix on the backend is going to become even larger and even more draconian. According to the CBO Social Security is projected to be insolvent by 2031 when the youngest of today’s retirees turn 73. Ignoring these programs is not the same as protecting them. It dooms beneficiaries to large abrupt benefit cuts across the board or large tax increases on the population as a whole. The debt is headed towards a new record, in just a couple of years, it is projected to grow faster than the economy indefinitely. All major trust funds are heading towards insolvency because we have done nothing to fix them. All of the Covid-19 spending would have been more palatable as we come into the crisis with our fiscal house in order. Whoever is in the White House in January is going to have to put a long-term plan in place to reduce the debt once the economy is strong enough and save Social Security and Medicare. The scary part is that we are starting to hear more about Modern Monetary Theory and the idea that we can just print our way out of our issues without creating immense amounts of inflation. Take advantage of tax rates while they are historically low because they are not going to stay at these levels for long.   Mentioned in this Episode: The debt is huge because Trump kept his promises - https://www.washingtonpost.com/opinions/2020/10/05/debt-is-huge-because-trump-kept-his-promises/

In every single book David has written he talks about why it’s so important to have a trusted and trained advisor in the Power of Zero paradigm. There are dozens of pitfalls standing between you and the zero percent tax bracket which is why it’s crucial you have a qualified guide to show you the way. You should work with an advisor that has internalized the Power of Zero principles to help you mitigate both tax-rate risk and longevity risk at the same time. The Elite POZ Advisor Group is a collection of trained professionals that have been vetted by David himself. There are a number of requirements that someone needs to have completed before they can enter the group. Elite Advisors need to have been in the industry for a few years and have demonstrated the ability to answer the client’s questions and lead them through the Power of Zero process. Every member of the Elite POZ Advisor Group has also passed a comprehensive written exam. Many advisors have tried and failed to complete this exam because you need to have an in-depth knowledge of the Power of Zero paradigm. Elite Advisors also have to sit through an extensive ten-part training course that covers a number of different case studies and covers all aspects of the Power of Zero retirement strategy. On top of all that Elite Advisors receive ongoing training directly from David to keep them apprised of tax law changes and updates on the approach. When it comes to getting to the Power of Zero tax bracket and tax-free retirement planning, not all advisors are created equal. The Elite Advisors group is the gold standard of the Power of Zero paradigm and if you’re working with one of them you can be assured that you are in good hands. Go to elite-poz.davidmcknight.com to find out what the advisors have been through to be part of the elite group. Advisors can go to powerofzero.com to find out how to become part of the Elite POZ Advisor group. There are a number of financial advisors preaching the Power of Zero approach but ultimately they just want to sell you a life insurance policy. That is not what the POZ paradigm is about. It’s about having multiple streams of tax-free income and there is no cookie-cutter approach. In the POZ paradigm, most advisors' basic impulses are the exact opposite of what they need to do to lead their clients to the zero percent tax bracket. Head to davidmcknight.com to be connected with an Elite Advisor to help you.

Should Donald Trump win a second term in the Presidency there could be significant changes to the tax code. Donald Trump hasn’t laid out a fully realized tax proposal in the same way that Joe Biden has but he has outlined some of the things he would do. One of the things that Donald Trump has already done is unilaterally implemented a payroll tax deferral as an answer to the financial repercussions of Covid-19. It’s currently deferred, which means that the money would have to be paid back in 2021, but there are rumors that he would waive that entirely. There have been additional rumors that Donald Trump is thinking about eliminating payroll taxes completely, which would put Social Security and Medicare in difficult positions as they are already underfunded. Unless you subscribe to Modern Monetary Theory (MMT) and the idea of the government’s infinity bucket, that’s probably a bad idea. The second thing Donald Trump would hope to do is modify the capital gains tax or index them to inflation. The idea being that the cost of doing business would decrease overall and to encourage investment. He has also proposed that the US indexes long term capital gains to inflation as well. David walks through a practical example of what this would mean for the average investor. Should this policy be implemented it would certainly have a positive impact on economic activity and investment in small businesses. The third thing that Donald Trump is considering is a reduction in taxes on the middle class. The current tax brackets are scheduled to expire in 2026 and Donald Trump is looking at a 10% tax cut for middle Americans, although the exact details aren’t known at this point. This particular policy could be interesting if implemented, but it would require the Republicans to have control of the House and the Senate to make the tax cut permanent. The fourth thing the President is looking to do is create tax credits for American businesses. He wants people to buy more American products so these tax credits are focused on making American businesses more competitive, particularly in the pharmaceutical and robotics industries. He’s also looking to expand the opportunity zones created under the Tax Cut and Jobs act. Keep in mind that none of these changes have been committed to or put down on paper, they’ve just been some thoughts and ideas discussed so far. David quickly recaps the five tax proposals coming out of the Trump administration. Once we know who our next President is going to be, we’ll have a little more clarity about what to expect in terms of taxes for the next four years.

There is a benefit in the tax code that goes largely ignored. The holy grail of financial planning is an investment that gives you a tax deduction on the front end, lets your money grow tax-deferred and allows you to take that money out tax-free. In the Power of Zero paradigm that usually means a combination of Roth conversions and LIRP conversions. For most married couples, the ideal balance of the tax-deferred bucket is between $300,000 and $350,000. In that situation it qualifies as the holy grail of financial planning. There is a second way to accomplish the same tax-free holy grail: through an HSA or health savings account. When you put money into your HSA you get a deduction, the money grows tax free, and when you take it out for qualified medical expenses you don’t pay any taxes at all. David breaks down the two scenarios of either having an HSA or not having an HSA in the event of a healthcare issue. With an HSA, healthcare expenses are not taxed. Most people go wrong with their HSA by not using all three tax advantages. They take advantage of the tax deduction on the front end and take the money out tax-free, but they’re not taking advantage of the tax-free interest in investment earnings. HSAs are designed to grow the investments inside of them. Instead of using the HSA as a slush fund for smaller, out of pocket medical expenses when you’re young, let your precious tax-free dollars experience the ability to grow in a tax-free environment. Use that money when you’re older after it’s grown and those medical costs are usually higher. Keep all your receipts for medical expenses along the way. There is nothing that says you need to get the reimbursement from your health savings account in the same year that you make the purchase. Let your HSA accumulate tax-free and build steam. It’s also important to keep the receipts in case you get audited. You will need to prove that you had a qualified medical expense and that you paid for it. With just a little tweak, you can use all three tax advantages that the HSA confers. Pay for your medical expenses out of pocket now and let that money accumulate tax-free. People don’t think of the HSA as the tax-free vehicle that it is, just like a Roth IRA. We are always told that we are either going to be taxed on the seed or the harvest, but with the HSA you are taxed on neither the seed nor the harvest. The problem is people don’t let their HSAs grow. If we can all make a little tweak to how we treat our HSAs, we’ll have another tax-free bucket to take advantage in the Power of Zero paradigm. There are lots of tax-free streams of income out there and we’re not taking advantage of all of them like we should.

A quick recap of the first principles covered in the previous episode. #1 Mitigate longevity risk with an income annuity. #2 Your income annuity only needs to cover your basic lifestyle expenses. #3 Your income annuity needs to have a guaranteed lifetime income feature, inflation protection, liquidity, and a death benefit feature. #4 Cover discretionary expenses with your stock market assets in your LIRP. #5 Always draw your guaranteed lifetime income from your tax-free bucket. #6 Your LIRP must have a chronic illness rider. The seventh principle is to use a time segmented investing approach to grow your assets safely and productively during the time when you are doing your piece meal Roth conversion. If you leave your money in your stock market portfolio you expose yourself to a sequence of return risk. Time segmented investing is about having bonds mature in the year when you know you will need the income and allows you to mitigate the sequence of return risk. Whatever money that isn’t going into your LIRP or annuity should be going into an aggressive stock market portfolio. Since you have the luxury of taking money out of your LIRP and guaranteeing your lifetime expenses, you can take much more risk in the stock market. You need to have multiple streams of tax-free income, none of which show up on the IRS’s radar, but all of which contribute to you being in the zero percent tax bracket. Preferably between four and six streams of tax-free income, each with unique benefits. Don’t take social security until you’re ready to draw income from your guaranteed lifetime income annuity. Outside of a short expected lifespan, you should be putting off social security as long as you can, at least until you’ve paid off your piece meal internal Roth conversion. Identify the ideal balances in your taxable and tax-deferred bucket and shift everything else systematically to tax-free. In a rising tax rate environment, there is an ideal amount of money to have in your taxable and tax-deferred bucket. As of right now, you have six years to reposition your money into the tax-free bucket. Get all your asset shifting done before tax rates go up for good. You have to know what your magic number is and how much money you need to shift to tax-free between now and 2026. Understanding these principles will shield you from longevity risk and tax rate risk. Unless you have the ability to mitigate both risks in the same financial plan, you are going to have a very hard time being fully at peace with your retirement plan. Nobody wants to have to keep constantly looking over their shoulder in retirement.