The Power Of Zero Show

There are 12 basic principles that make up the Grand Unified Theory when it comes to retirement planning. The first section tackles mitigating longevity risk. We know there are two basic ways to mitigate longevity risk, the first simply being to save up enough money. If you save enough money you can weather all the ups and downs of the stock market. Historically, there has been a 4% Rule that makes the calculation simple. More recently the rule has been revised. The new 3% Rule is more common. If you need $100,000 per year in retirement the 3% Rule says you need $3.33 million to successfully mitigate longevity risk. This is a very expensive way to mitigate longevity risk but it can be done. A better option is an income annuity. The number one principle is to mitigate longevity risk with an income annuity and not by way of the stock market. The second principle is to only use the income annuity to cover certain expenses, essentially your basic lifestyle needs. You just need to cover simple lifestyle needs because other vehicles are better suited to other expenses. The money that doesn’t go into the annuity needs to be grown and compounded in another part of your portfolio. The third principle is that your annuity has to have four qualities that you absolutely must have before you commit. It must have a guaranteed lifetime income feature and is designed to last as long as you do. It must have inflation protection because without that inflation could erode your value and leave you looking at a shortfall. Your annuity should also have liquidity in the years prior to electing that guaranteed lifetime income feature. Not all annuities have liquidity which can give people a sense of heartburn in the case where they need that money. That last component is a death benefit feature. Without this, there is the potential for the annuity to be the worst investment you’ve ever made. With the death benefit feature, in the case that you die earlier than expected at least, your beneficiaries will get the portion that wasn’t spent. Once your lifetime expenses are covered by your annuity, you need to look at the rest of your portfolio. There are two types of discretionary needs, emergency expenses, and aspirational expenses, and they will pop up over the course of your retirement and you have to have the ability to grow your money productively to take care of them. You will have two pools of money to draw from to cover those expenses, the first is your stock market portfolio and the second is your LIRP. The rule of thumb is to draw money from your LIRP during down years in the market during the first 11 years, but when the market is up you are simply harvesting the profits from your portfolio. Never withdraw assets from your stock market portfolio following a down year in the market. If you are planning on having an annuity to cover your lifestyle expenses in retirement, you need to draw that money from your tax-free bucket. The idea that annuities are only tax-deferred is a misconception. You should be using piecemeal internal Roth conversions to convert your IRA to a Roth IRA, taking however much time you need to stay in a low tax bracket. This is very important because if you draw that guaranteed lifetime income from your tax-deferred bucket, it will always be taxable. As tax rates go up, the amount you get to keep goes down. It can also lead to social security taxation and running out of money ten to twelve years faster. The last principle is to make sure your LIRP has a chronic illness rider. In retirement, one of the things that can really upset your financial position is a long term care event. A chronic illness rider gives you the ability to spend your death benefit for the purpose of paying for long term care. A quick summary of the first six principles of the Grand Unified Theory on a happy retirement.

Joe Biden has historically said that taxes won’t go up for anyone that makes less than $400,000 annually , but that may not be the case. Some people may lose some deductibility in their 401(k) contributions which would result in an effective increase in the tax they are paying. If you are in the highest marginal tax bracket of 37%, when you contribute $1 to your 401(k) you essentially save $0.37 in tax. Joe Biden’s perspective is that for people in higher income tax brackets, the tax savings is unduly weighted towards them. The current proposal involves a standard rate at which everyone could deduct money from their 401(k). The exact number is still unknown, but economists are estimating the rate would have to be around 20% to be revenue neutral. This would basically mean that instead of deducting the full $0.37 at the highest marginal tax bracket, you would only deduct $0.20. For people in lower tax brackets, they would get a higher deduction than they otherwise would have. The ramifications of this proposal would mean that people in the higher income tax brackets of 22% or above will skip the deduction. Instead of getting the deduction, higher income earners will likely start paying the taxes on their money today, especially given that we are in a rising tax rate environment. This negates the usual discussion about whether it’s superior to save on paying the taxes today and waiting until retirement, since the deduction is not likely to be much higher than the tax rates you will face in the future. The net effect of all this is that it is going to accelerate the flow of money into tax-free accounts. As things are, there isn’t much reason to forego a 37% deduction today, but if that deduction changes, it’s not going to be very attractive at all. Given this proposal, we are going to see more people foregoing putting money into their 401(k) and looking more towards tax-free options. Despite Joe Biden’s pledge to not raise taxes on anyone making less than $400,000, people who make $200,000 or more will find they will be paying more taxes if they no longer have the ability to deduct 401(k) contributions at their highest marginal tax bracket. Anyone who is in the 22% tax bracket or higher will likely stop making 401(k) contributions and start redirecting those contributions to Roth 401(k)’s or other tax-free plans. The silver lining to this is that more people will contribute to tax-free accounts and end up being better prepared for an eventual rise in tax rates. If Biden does get elected in November, many people are going to have to reassess their approach to saving for retirement. Another thing to keep in mind is the rumor that should Joe Biden get elected, he may bow out at the two-year mark. This could potentially lead to 10 years of Kamala Harris in the presidency.

There are five important elements your LIRP must have if you are going to have it for the rest of your life. Similar to getting married, these are things you need to look for before committing to the plan. You don’t want to get 10 or 20 years in before you realize there is a ticking time bomb in your LIRP. The first thing your LIRP must have is the ability to get a guaranteed zero percent loan. The best strategy for your LIRP is to work with a company that allows you to take a loan against your plan with a net cost to you of zero percent. This means you have to be diligent in assessing the contract and make sure the guarantee is part of it. Some companies reserve the right to adjust the loan interest rate at their leisure which is exactly what you want to avoid. The caveat is here is that just because someone is saying that they are giving you a zero percent loan, that doesn’t mean it’s guaranteed. This is one of the most important provisions in your contract. The second thing to look for is interest in arrears, not interest in advance. The problem with interest in advance is the lost opportunity cost over the course of the year. Some companies credit you in a way that makes interest in advance work in your favour, but they are few and far between. The third thing to look for is a strong financial rating. There are several rating companies, and the way they rank financial products can vary, or even contradict each other. The best way to determine the financial footing of a company is to use a Comdex rating instead. A Comdex rating below 90 is a sure sign you should avoid that company, and ideally, you’re working with a company with a rating of 95 or higher. The fourth thing your LIRP must have is called an overload protection rider. In order for your death benefit to pay out, your cash value must be at least $1. If your cash value runs out before you die, there are some intense tax repercussions. An overload protection rider is like a failsafe that protects you from that scenario by lowering your death benefit. The last thing your LIRP absolutely must have is a chronic illness rider. This rider allows you to access your death benefit in advance of your death for the purpose of paying for long-term care without paying anything along the way. Compared to a long-term care rider, where you are paying money along the way for the privilege of receiving 25% of your death benefit in advance of your death, the chronic illness rider is superior. If you pay for a long-term care rider throughout your retirement and you die peacefully in your sleep without ever having needed long term care, all of those expenses were a drag on your cash value along the way. You end up having paid for something that you never had to use. A chronic illness rider doesn’t have the same opportunity costs. For more info on the 20 things your LIRP must have, check out the book Look Before You LIRP, preferably before you commit to a life insurance policy that doesn’t have what you need in it.

It is possible to convert too much money to your Roth IRA and not leave enough money in your IRA to use when you’re ready to retire. The first principle you have to realize is that in a rising tax rate environment, it’s okay to have some money in your tax-deferred bucket. You have to be very strategic about how you shift your money to tax-free and shouldn’t be too reckless when it comes to converting. You can have too much money in your tax-deferred bucket, you can have too little, what we are looking for is just the right amount. You should have a balance in your tax-deferred bucket that’s low enough that required minimum distributions are equal to or less than your standard deduction, but also low enough that it doesn’t cause social security taxation. Social security taxation could put a $6000 hole in your social security, which will require you to spend down your assets much quicker to compensate. Check out davidmcknight.com and use the Magic Number calculator to figure out the perfect balance you should have in your tax-deferred bucket. The higher your social security, the less money you should have in your tax-deferred bucket. Having too little in your tax-deferred bucket can also be a problem. If you rush into converting all your money to tax-free you may end up paying considerably higher taxes along the way, completely unnecessarily. If by the time you’re 72 you don’t have any money left in your IRA, your standard deduction is left idle. This means that in the process of executing your Roth conversion, you paid some taxes along the way that you didn’t need to pay and have over-converted your Roth IRA. You have to keep in mind the opportunity cost. Any time you pay a dollar to the IRS that you didn’t need to pay them, not only do you lose that dollar but you also lose what that dollar could have earned for you had you been able to invest it. As a general rule of thumb, if you have a large pension your ideal balance in the tax-deferred bucket is going to be zero. For everyone else, the typical range is between $250,000 and $400,000 depending on the sources of provisional income you’re expecting. All streams of provisional income will affect your ideal balance. The more you have, the smaller the ideal balance in your tax-deferred bucket. If you should have had $400,000 in your IRA but converted it unnecessarily to tax-free you will have probably paid at least 25% of that as taxes. What could you have done with that lost money? While your standard deduction does index for inflation over time, your provisional income threshold does not. If you want to avoid social security taxation, you need to keep your tax-deferred bucket under a static number. The Power of Zero approach typically includes having 4 to 6 different sources of tax-free income, the most common of which are RMDs. Tax-free RMD’s are the holy grail of financial planning because when you put money in the front end you get a deduction, it grows tax-deferred, and when you take it out it’s tax-free. The RMD should be used as a compliment to other tax-free sources, not the only one you are relying on. It’s okay to have some money in your tax-deferred bucket. Sometimes in our zeal to get our hard-earned money over to tax-free, we needlessly pay taxes along the way, and that’s the massive mistake we’re trying to avoid. If you get your tax-deferred balance down to zero, your standard deduction will sit idle.

A government can’t simply print however much money they want to be able to buy whatever it is that they want. The Deficit Myth was recently released and in the book the author argues that because the government issues its own currency, it doesn’t have to operate like a traditional household. According to the author, all we need to do is print $239 trillion and the US will be funded for the next 75 years. Stephanie Kelton is a proponent of what’s known as modern monetary theory, which is essentially the belief that the government can print its way out of its problems at any time. One argument for this theory is that it’s okay to inflate the money supply as long as the economy inflates at the same rate. The trick is in what proponents of the theory are proposing they use the newly printed money for. The Green New Deal has an estimated price tag of $93 trillion, but if that money were printed today would it actually productively grow the economy? The government can’t replace the productivity that takes place in a free market economy. The government can’t guarantee that a job that it creates is going to benefit the economy in the same way that a private enterprise, when they create a job, can grow the economy. Governments tend not to be able to allocate resources efficiently in the same way a private enterprise can. Elon Musk just sent two astronauts into space in the first commercial space flight, and he did it far more efficiently and quicker than his government counterparts. Some of the biggest criticisms of modern monetary theory come from the left hand side of the aisle. Paul Krugman has warned the US will see hyperinflation if they adopt the theory. Inflation is a type of tax, but it’s more insidious than a tax increase because at least with a tax increase your representatives have to vote on it. Inflation is like a hidden tax that devalues your money in the same way as tax increases but without any legislation. If the government printed money to pay off the national debt, we know that inflation would rise and that would decrease the value of US bonds, resulting in a sovereign debt crisis. This eventually leads to a spiral of rising interest rates and crowding all other expenses out of the budget. Printing money ultimately creates more problems than it solves. There are three programs that are primarily driving our national debt; Social Security, MediCare, and Medicaid, and those programs are tied to inflation. The US can’t print its way out of its problems, the only option is to raise more revenue via higher taxes. Modern monetary theory is dangerous to the US economy and population and will eventually result in major problems for everyone involved. In the end, we need to become more fiscally sane and fundamentally respect the financial laws of the universe. We know that we shouldn’t spend more than we bring in, so we have to be wary of approaches that fly in the face of common sense.

There is a well-known economist named William Bernstein who originally asked the question “When you’ve won the game, why keep playing?” But should people who are retired avoid the stock market completely? An article on the Motley Fool follows the same line of thought. You do need a plan for withdrawing your money in retirement that is different from your plan for building your nest egg and it needs to be in place before you need to withdraw from your assets. A good rule of thumb is to not have money that you expect you will have to spend in the next five years invested in stocks. If you want to mitigate longevity risk and tax-rate risk, the only way is to have an annuity that gives you a tax-free stream of income for life. If it’s inflation adjusted, that’s even better. The issue is that most annuities are implemented in the tax-deferred bucket. You must find an annuity that allows you to do a Piecemeal Internal Roth Conversion and convert that annuity over time to a Roth IRA. Accomplishing this during the first five years of retirement is where most people run into problems. Chuck Saletta doesn’t completely discount the idea of investing in the stock market during retirement, but believes that for the money you need several years from now, the stock market is one of the few ways to generate the returns you need to accomplish those goals. Ultimately, as you transition to relying on your portfolio to cover your costs of living, you will want to strike that balance between short and long term money. Just because you’ve won the game, that doesn’t mean that you can’t do even better over time. In the Power of Zero paradigm, after you have set up the systems to afford your lifestyle expenses in retirement you will still have other discretionary expenses that will arise. These can include healthcare expenses, family requirements, or aspirational expenses and go above and beyond your lifestyle requirements. Any money that is not earmarked to paying for lifestyle expenses, taxes on Roth Conversions, and LIRP contributions during the first five to six years of retirement should be allocated to an aggressive stock market portfolio. This gives you the ability to wait a year and allow the stock market to recover if necessary before drawing money from your portfolio. The bottom line is that you need to keep money invested in the stock market for all the expenses that will be earmarked after the Roth Conversion. You need to grow that money as efficiently as possible over the expected 30 years of your retirement if you want to have any hope of being able to pay for your discretionary expenses. Just because the numbers say you’ve won the game, that doesn’t mean it’s time to take all your money out of the stock market. Instead, you should be guaranteeing your lifestyle expenses and anything else above that you can invest and take more risk on. Clients of the Power of Zero paradigm will also be funding their LIRP during the first five to seven years of retirement, which grows safely and productively and can be used to cover discretionary needs after the eleventh year. You should not be taking risk in investments that are going to be used to fund expenses early on in retirement. Work with your advisor to create a timeline that incorporates the right level of risk with investments that mature at the right times during your retirement. Once the Roth Conversion period is up, whatever money is not earmarked for the first five or six years of your retirement should be allocated to your high octane stock market portfolio so you can pay for any additional expenses you will need to cover. Stocks are not toxic once you retire, it is absolutely necessary that you continue to invest in stocks in such a way that your account lasts long enough to cover your discretionary needs during the balance of your retirement.

The Piecemeal Internal Roth Conversion (PIRC) may be indispensable to your retirement plan. There are two massive risks that could waylay your retirement journey and prevent you from living a happy and stress free retirement. The first is tax rate risk, the risk that tax rates in the future will be dramatically higher, and the second is longevity risk, where you run out of money before you die. Historically, financial planners have been decent at mitigating either one or the other of those risks but rarely good at mitigating both. If you’re mitigating tax rate risk, you are executing a series of Roth conversions in a way that stretches out your tax liability over time but quickly enough that you get it done before tax rates go up for good. You should really try to get your financial house in order before 2030 if possible. Dealing with longevity risk is fairly simple and involves accumulating more money in your retirement portfolio but this can be a challenge for most people. The 4% Rule has fallen out of favor in recent times and that means using your stock market portfolio to fund your lifestyle needs has become much more expensive. The other option is to offload that risk to companies that deal in mitigating that risk but they typically come with a few downsides. A fixed index annuity is another option that people have traditionally used to mitigate longevity risk. The problem with the traditional approach that financial advisors use to mitigate longevity risk is they typically do it to the exclusion of mitigating tax rate risk. 99% of advisors implement a fixed index annuity within the tax-deferred bucket and once you begin receiving that income it is impossible to receive that income in any other way. If you draw a guaranteed stream of income via an annuity in your tax-deferred bucket, the whole purpose can be thwarted if tax rates go up. If tax rates double in the future and you are relying on that income, you will have half as much money as you expected and will have to spend down your other stock market assets to compensate. The second issue is that the money will count as provisional income and cause social security taxation, compounding the problem and requiring more money to come from your stock market portfolio. Combined, these problems can lead to running out of money 7 to 10 years faster. Many companies allow you to do a Roth conversion prior to drawing against the annuity but they usually require you to convert the entire dollar amount in the same year. This can result in most of that money being taxed at your highest marginal tax bracket. There are only a few companies that allow you to do a Piecemeal Internal Roth Conversion where you can do those conversions over whatever timeframe your financial plan calls for. By getting the conversion done before tax rates go up for good, you have insulated your guaranteed stream of lifetime income from tax rate risk and when coupled with other streams of tax-free income, this can cover your lifestyle needs in a guaranteed way for the rest of your life. The traditional approach to mitigating longevity risk permanently exposes you to tax rate risk. Insurance companies and advisors have not been historically interested in mitigating both types of risk and you need to find an annuity company that offers a Piecemeal Internal Roth Conversion feature if you want to find the right solution.

David often gets the question of whether a person can be too old to implement an LIRP and like most questions the answer is “it depends”. There are a number of great reasons to implement an LIRP, but you have to keep in mind that it’s not a silver bullet for your retirement and should be paired with other streams of tax-free income. The first benefit of the LIRP is that the money in your account grows safely and productively, but that also means that you’re not going to hit any homeruns inside that account. The LIRP is often used as the bond portion of your portfolio which allows you to take more risk elsewhere. Money in an LIRP also grows tax-free and can distribute the money tax-free via a variety of loan options. The next big advantage of the LIRP is the death benefit, which usually has to be the primary motivation for acquiring an insurance plan. You have to have a need for life insurance and a death benefit. A lot of people are using the LIRP as an alternative to long term care insurance. Many people think that as they get older the money coming out of their LIRP will prevent their cash value from accumulating, but that’s just a misconception about the guidelines around the LIRP. As you get older the amount of death benefit the IRS requires you to have goes down. There does come a point in time where the ratios of the LIRP no longer work in your favor. We need to look at the expenses over the life of the program because as life goes on the average cost of an LIRP goes down, this means that you need time to make that happen. If you get too old by the time you implement the program you don’t have enough runway. You don’t have enough time to allow the expenses to reduce. Many of the benefits are still present but you won’t be able to use the LIRP as a distribution tool over the age of 65. The LIRP can be a great way to pass on money to the next generation, to cover a long term care event, and still have a death benefit, but you probably don’t want to use an LIRP after age 65 if your primary motivation is accumulating money tax-free and then distributing money tax-free. For paying for a long term care event an LIRP will always be a good option, it’s just that one of the main benefits of the LIRP no longer applies once you implement it after age 65. The plan still has a lot of good attributes, and it will mainly depend on what you want to get out of it.

In past episodes of the podcast David described the impact of a blue wave in the upcoming November election and what may happen to your finances if Joe Biden becomes the next president. The first major change would likely be the loss of the stepped up basis which could result in a large increase in the taxes on money you inherit in the future. No matter who gets elected in November tax rates will have to go up. There is a rumour that a fifth part of the Covid-19 relief bill will be coming in the next few months and the US will likely be at least an additional $4 trillion in debt by the end of the year. Biden currently has a probability of 55% of becoming the next president in November according to the odds in Vegas. A lot can change by the fall but that’s where the odds sit at the moment. Unlike Elizabeth Warren, Joe Biden is not pushing for a wealth tax. The biggest takeaway is that Biden is not talking about raising taxes on anyone making less than $400,000 but he is talking about raising taxes on the wealthiest Americans prior to 2026. This would require a change in the existing law, but the Republicans are trending towards losing the Senate which means it is a possibility. This would probably mean the 37% tax bracket would go up to 39.6%, but all the other tax brackets would remain the same. This would also mean that come 2026, you would not experience a reversion to pre-2018 tax rates and could actually make the tax cuts made at the end of 2017 permanent. We can’t keep tax rates this low for very long without some very unpleasant consequences for Social Security and Medicaid and this may be a way to do some political maneuvering in the meantime. If the expiration date of the current tax cuts becomes null and void due to a change in the law, that could mean you won’t have the same urgency to condense your conversions in the remaining six years. Corporate tax cuts will go up from 21% to 28%, which will have an impact on GDP. Biden is also looking at capping the value of itemized deductions at 28% which would be a stealth way of eliminating deductions for the top earners. Biden is not levying any direct taxes on the middle class, but they will have to shoulder the burden of the other tax increases as those increased costs are passed on to consumers. The increase in taxation amounts to about $3.4 trillion over the next decade, but that money is not earmarked to pay down debt or create efficiencies in the federal government. It’s all designated towards increased spending above and beyond what we are already paying for. David Walker tells us we need to either reduce spending, increase revenue, or some combination of the two. Biden is increasing revenue but also increasing spending, so he will not be doing anything to solve the structural issues in the US entitlement programs. By 2026, the amount of interest on the debt will be taking up a considerable amount of the federal budget and crowding out all the other spending. Every article says we have to pay down the debt. If we are not addressing the debt with all this increased spending we are hamstringing ourselves as a country and we will be forced to make some very tough decisions by the end of this decade. It’s not about whether the additional programs are good or bad, it’s about the implications of this tax policy for the future viability for the country. Taxes will have to increase even further to get us out of this terrible position. If the 2017 tax cuts become permanent, that means you have a wonderful opportunity to pay lower taxes in converting your taxable money to tax-free. It is possible that taxes will be reverted to 2017 levels but that doesn’t seem to be the case. Biden will also probably raise the threshold on wages that are subject to Social Security tax and MediCare tax, but anytime you take money out of the economy and put it into federal programs, that money is not being used as efficiently. If Joe Biden does get elected there will be changes on a number of fronts where the average American will not see an increase in their personal taxes, but will feel the impact of the increase of corporate taxes in higher prices.

Time-segmented investing is a critical concept in the Power of Zero paradigm. The traditional approach says that you can have an investment portfolio balanced in such a way as to protect against systemic risk, but this approach has a serious risk associated with it. A couple of down years in the stock market during a time when you are withdrawing funds from your portfolio can lead to you running out of money up to 15 years faster than you expected. The 4% rule is how people typically protected themselves against that risk but changing times have made that rule pretty antiquated. Now it’s as low as the 3% or 2.5% rule. This also means that in order to live comfortably, many people will need considerably more money in their retirement funds if they want to avoid sequence-of-return risk. During the first ten years of retirement, traditional asset allocation is not the best way to go about funding your lifestyle needs. You need to have six different portfolios that are calculated to produce a certain amount of money at certain times. Each portfolio should be calculated so that it provides the money you need at specific points of your retirement. This allows you to take an amount of risk commensurate with the time horizon when you will need that money. If you know how much money you will need in certain years, you can calculate the exact right amount of money you need for each time segment to generate those results. Anything earmarked for years 11 or later will be placed in a high growth portfolio with a higher amount of risk, because you can afford to take the extra risk. Given the low risk investments for the first ten years and the higher risk investments after year 11, you end up with a standard deviation similar to a traditional portfolio but you have completely eliminated sequence-of-return risk. There are also ways to eliminate longevity risk and guarantee a stream of income for your lifestyle needs in retirement. A piecemeal internal Roth conversion inside an annuity is the key, but it does come with some conditions. If you know from day 1 of retirement that you are going to have your lifestyle needs covered by time-segmented investment for the first seven years, you now have the luxury of taking more risk in the stock market. Sequence of return risk is only dangerous when your lifestyle needs are not guaranteed for the first ten years.