The Power Of Zero Show

David Walker has been saying that tax rates are going to have to double since 2008. We didn’t do that. So that means the national debt will continue to accumulate until we reach $53 trillion, at which all the money flowing into the Treasury will only be enough to pay the interest on the debt. Many people other than David Walker are starting to speak about the future of tax rates as the national debt continues to skyrocket. Ray Dalio has said that the US will have little choice but to raise taxes in the coming years to offset its mounting liabilities and debt. In many ways we are looking at a currency problem, not just a debt problem. Leon Cooperman believes that no matter who wins in the coming November election, taxes are on the way up, and the coming tax revamp is going to change capitalism forever. The only variable is how high and how fast tax rates will go up. Leon spoke favourably in the past about the tax cuts implemented by President Trump and why the wealth tax proposed by Nancy Pelosi is pretty much impossible to implement, let alone being unconstitutional. Ed Slott believes that there is a good chance that tax rates will go up before 2026. Should Joe Biden get elected, the tax sale may very well come to an end earlier than expected. Larry Kotlikoff, one of the most famous accountants in the world, is recommending that people implement the Power of Zero principles for their clients. The cost of converting a portion of your stock market portfolio will be lower today than at any other point in your lifetime. There are a few good reasons not to buy municipal bonds in general, but Larry offers another reason. Larry Swedroe echoes much of what Larry Kotlikoff has said. Whatever party is in power, we are likely to see a significant increase in taxes before 2026. More and more experts are seeing the writing on the wall and saying that we will have to endure higher taxes in the near future. Even the most skeptical of experts are coming around and are realizing what’s happening. You must take on a sense of urgency when it comes to your taxable buckets. If you still have money above and beyond the optimal amount in your taxable bucket, you are exposing yourself to some serious risks. You’re much better off paying taxes now than later.

The Before and After Comparison is an indispensable part of the financial planning process and you can get help with yours over at davidmcknight.com. The comparison is made up of three different projections within some sophisticated financial planning software of side-by-side-by-side life scenarios. The comparison reveals the impact of using the Power of Zero paradigm on your retirement funds. The first projection shows what happens if you continue doing what you are doing right now under the unlikely assumption that taxes don’t rise in the future, and shows how long your money will last. This works as a baseline for the next two comparisons. David Walker has said that tax rates will have to double in the future to keep the US solvent, that’s why the second comparison focuses on what happens to your retirement picture under those conditions. There are a few important things to keep in mind when tax rates double. The first is that it takes much more money to meet your lifestyle needs, but also when tax rates go up that means your Social Security also gets taxed at a higher rate. This leads to spending down your assets that much faster. The average person will run out of money 12 to 15 years faster when tax rates double. The third comparison shows what happens to your finances if you implement all the Power of Zero strategies and how multiple streams of tax-free income will affect your retirement. The point of the comparison is to put a price tag on inaction. You don’t have to love Roth IRA’s, or LIRP’s, or Roth Conversions, you just have to like what they do for you and like them a little more than the IRS because, in the end, someone is going to get your money. The comparisons also measure tax rate risk and show you how long your money will last under multiple different scenarios. The Before and After Comparison can be very valuable by showing how much better off you could be when you implement the Power of Zero strategies, but not everything can be quantified. It’s hard to quantify how important it is to you to protect yourself from a long term care event or sequence of return risk, but those do have to be factored in. The bottom line is the Before and After Comparison will show you the cost of inaction so you won’t be haunted by the reality of letting the opportunity go by. There are huge opportunity costs when you don’t implement these strategies. If you give a dollar to the IRS that you didn’t really need to give them, not only do you lose that dollar, you lose what that dollar could have earned for you had you been able to keep it and invest it over the balance of your lifetime. If this is so important, why didn’t my current advisor bring this up to me? There are two reasons why, and it’s hard to know which one is worse. The Before and After Comparison also comes with a roadmap that shows you what you need to do each year to realize the advantage of the Power of Zero paradigm. Taking the roadmap to your current advisor may not be the best idea. Do you really want to be your advisor’s guinea pig as they experiment and learn these strategies? There are a number of different thresholds that need to be navigated to maximize the Power of Zero paradigm so working with an experienced advisor is highly recommended. Advisors that want to be able to create and implement these strategies for their clients can learn more at powerofzero.com.

Every once in a while the idea of fixing all our fiscal problems by taxing the top 1% of the population is proposed, but it’s time to do the math and see if it’s true. The Committee for a Responsible Federal Budget put out a report a few years ago, prior to the latest spending due to Covid-19, where they analyzed what it would take to actually balance the budget. The first scenario looks at balancing the budget by not adding any more to the existing debt. The challenge with this scenario is that the interest on the existing debt will crowd out other expenses in the federal budget over time as interest rates rise in the future. In order to balance the budget of the federal government by increasing taxes on only the top marginal tax bracket, they would have to increase it to 102%. Everything earned over $400,000 would be taxed at 100% and then some. When they looked at how high tax rates would have to go if they included anyone that made more than $250,000 a year, the tax rates would have to be 90%. If they went down to $150,000 a year the tax rates would be around 80%. When the committee looked at increasing everyone’s taxes to balance the budget over 10 years, taxes would have to go up to 49% across the board. If you think that you stay in the 24% tax bracket and not be affected by the current fiscal situation the math isn’t looking good. What if the government didn’t want to balance the budget but just maintain the current deficit? The top tax rate would have to go up to 60%, or if applied across the population no matter how much they earned, everyone would have to pay a 42% tax rate. Our fiscal condition is more dire now due to Covid-19 so these numbers aren’t drastic enough. The moral of the story is that our current financial crisis is irreversible and can’t be solved by just taxing the rich, the only solution is to broaden the tax base. When you confiscate 100% of what people make you encounter the Laffer Curve. At whatever the cut off point is those people will just stop working and you will ultimately kill the economy. You also need to keep in mind that when a politician talks about taxing the rich today, they are talking about using that money to fund another program, not to deal with the debt crisis. Taxing our way out of the problem isn’t going to work very well, even if we taxed everyone in the country and spread the burden out, let alone just by taxing the rich. You are not immune to tax increases just because you’re not in the top 1% in terms of wealth.   Mentioned in this Episode: Can We Fix the Debt Solely by Taxing the Top 1 Percent? https://www.crfb.org/blogs/can-we-fix-debt-solely-taxing-top-1-percent

David moved his family to Puerto Rico about three years ago and within six weeks of arriving they experienced something that completely changed their lives. It’s been three years since Hurricane Maria hit Puerto Rico, but there are still residents with significant damage to their house. When deciding to move his family to Puerto Rico, the idea of a hurricane wasn’t even a concern since the last major hurricane to hit the island had happened in 1928. Unfortunately for David and his family, Hurricane Maria turned out to be a category 5 direct hit. While the damage to the house was significant, the damage and destruction of the surrounding rainforest was tragic. With resources running low once the storm had passed, the McKnight family was forced to evacuate. David had to drive around for an hour in order to find a place with a strong enough cell phone signal so he could call and reserve plane tickets for him and his family. David’s family was able to board and evacuate safely but his own reservation was canceled and he had to scramble to reserve another flight. All lines of communication were down for several days but against all odds David’s friend Brian was able to secure a ticket. Puerto Rico struggled for months after the storm to restore electricity and lines of communication while rebuilding the damaged infrastructure, with many areas still suffering the effects of the hurricane three years later. Prepare for the storms of life no matter what form they take, preferably before the storm is about to hit. Not every experience has a financial lesson, but Hurricane Maria taught David something very valuable, namely cataclysmic events happen when you are least expecting them. Take some time now to prepare for the contingencies that life can throw your way because there is always something unexpected in your future.. The story ends well with David and his family moving back into their house in Wisconsin that hadn’t sold yet. His kids were able to complete their school year in their old neighbourhood and they were able to move back to Puerto Rico over the summer once the situation had mostly returned to normal. If you like warm weather, good people, and big tax benefits, Puerto Rico is a place you should consider moving to.

Not everybody is going to get an inheritance but there are some very important strategies you can implement to minimize your taxes if you are going to receive one. The ultimate goal of the IRS, no matter how you inherit money, is to get all of the inheritance money into your taxable bucket within the next 10 years, preferably immediately, because that is how they make the most money. We know that if you inherit money from a taxable bucket you get a stepped-up basis for those investments. Since these investments end up in your taxable bucket, you’re going to pay ordinary income tax on that. When you inherit money from a tax-deferred bucket it goes into your tax-deferred bucket, however the IRS will force you to realize that money within a ten-year timeframe. If you inherit a tax-free investment like a Roth IRA you will continue to experience the tax-free growth over the next ten years, but at that point it will all go into your taxable bucket. The goal of the IRS is to always move your money into the taxable bucket whenever possible. Your job upon inheriting money is to put together a plan that moves the money over into the tax-free bucket as quickly as you can. When you have money in your taxable bucket, there are a number of different things you can do to get that money into the tax-free bucket. The first step is to make sure you and your spouse are fully funding your Roth IRA’s, as well as your Roth 401(k)’s. The easiest way to get money into your Roth 401(k) is to increase the amount of money coming out of your paycheck to fund your account, and then compensate for that reduced pay amount with the money from the inheritance. Remember there is an ideal amount of money to keep in your taxable bucket and a great way to spend that money is by paying the tax on Roth conversions. The final way to move an inheritance into the tax-free bucket is the LIRP. There are a number of advantages that come with the LIRP and the only thing really limiting you is the size of your death benefit. The ideal way to have money flow to you is through the tax-free bucket. If it comes to you in your taxable bucket at the peak of your earning years when taxes are higher than they are today you could end up losing up to 50% of those inherited IRA’s. If it’s not too awkward, you should be having this discussion with your parents to figure out a plan that allows them to convert their dollars to tax-free. Keep in mind that when one parent dies, the surviving parent’s tax bracket doubles and they will be forced to receive their Required Minimum Distributions and pay taxes at double the tax rate. It makes a lot of sense for everyone involved to preemptively shift those dollars to the tax-free bucket. If you’re building your Power of Zero retirement strategy right now and know you are going to be inheriting a large sum of money in the next 10 years, there are a number of things you can do with an LIRP to make it big enough to accommodate those dollars. Get your buckets in place to accommodate any future dollars you may be inheriting.

A Coronavirus-Related Distribution (CRD) is any distribution by a person diagnosed with Covid-19, this can also include a spouse or dependent. Alternatively, if you’ve been adversely affected by the Coronavirus in some way, for example being furloughed, you may qualify as well. The CRD allows you to withdraw up to $100,000 from your qualified plan and if you’re younger than 59½, the 10% penalty is waived. Another benefit is you are allowed to pay the money back over the course of the next three years. The IRS treats this as a rollover instead of a contribution so you’re not constrained by the traditional contribution limits. This is where the Roth Conversion loophole comes in. You have the opportunity to recharacterize the money and contribute it into a Roth IRA, and because of the extra benefits that come with the CRD, it’s possible to avoid the 10% penalty you would normally face. This provision allows for someone younger than 59½ to take the money out, retain a portion of it for taxes, and put the rest into their Roth IRA. David runs through a hypothetical example of what this means for the average taxpayer under 59½. The question is whether this strategy is morally permissible for someone affected by the Coronavirus. The spirit of the rule suggests that the answer is yes but only if you are actually adversely affected. This is a loophole, and what do we know about loopholes? When they get abused, eventually the IRS catches on. The IRS reserves the right to change the rules, and if they think people are abusing the CRD, they may come after the people they believe took advantage of it. This doesn’t diminish the importance of taking advantage of Roth Conversions. This is the greatest opportunity in the history of our country to do Power of Zero-type planning. There are two sales going on right now, taxes are historically low at the same time as the stock market is down. The CRD Roth Conversion loophole is available for those that want to take advantage of it, but if you haven’t actually been affected by the Coronavirus it could cause you problems with the IRS in the future. Check out The Hallmarks of a True Power of Zero Advisor podcast episode to learn how a true Power of Zero advisor can help you set up multiple streams of tax-free income.

The US is very likely to default on its debt at some in the future, but we’re just not sure exactly when. What we do know is that the sooner it happens to smaller the impact will be, but that doesn’t seem like it’s going to be the case. The reality of our financial situation as of May of 2020 is the US is on course for a $3.7 trillion deficit this year. According to Jerome Powell, we are going to need another stimulus package and could be looking at a deficit of over $5 trillion, a number which normally takes five years to reach. All of the predictions made in the past have all been accelerated because of the increased deficit spending this year. For governments, it’s more attractive to raise taxes than it is to default on their debt because of the devastating consequences of doing so. Essentially, if Congress declines to raise the debt ceiling the US Treasury Department can no longer issue bonds and the federal government wouldn’t be able to fund all its obligations. We have to understand the implications of default. The current debt to GDP ratio of the US is 110%, but it’s actually much higher than that if you include unfunded obligations like Social Security, Medicare, and Medicaid. Timothy Geitner once discussed the implications of what would happen if Congress did not raise the debt ceiling and how it would impact everyone. Defaulting on the debt is not the same as a government shutdown. It’s far worse. The second way the US could default on its debt would be by not paying the interest on the debt, in which case the value of the US Treasuries would drop like a rock and come with its own set of major problems. In the case of a debt default interest rates will also rise dramatically because creditor countries will justifiably see the US as more risky. Other countries would no longer be willing to finance our debt spending unless we pay a lot more. Even the threat of debt default is bad, when the credit rating of a country is downgraded interest rates go up and the effects can be felt throughout the economy. A debt default would also affect the stock market as investments in the US would become riskier as people and countries no longer see the US as the safe haven it used to be. This would precipitate a global depression. The first opportunity for debt default comes in 2035 but it could come sooner. The surest way to prevent a debt default is to prevent budget spending that leads to additional debt and raise more revenue. The trouble is reducing spending isn’t going to be easy. As we accumulate more debt and march into the future, the likelihood of taxes going up becomes all the more inescapable. The cost of servicing the debt will eventually become such a huge part of the budget that the government will have to look for revenue raising activities to pay its bills, i.e. taxes. For people saving for retirement they have to position themselves with the right amount of dollars in the right buckets. You should have six months of expenses in your taxable bucket, a balance low enough in your tax-deferred bucket that your RMD’s are equal to or less than your standard deduction, and everything else systematically shifted over to your tax-free bucket.

The federal government has waived the Required Minimum Distributions for 2020. There are 20% of Americans who don’t spend their RMD’s which means that 80% of the population relies on those RMD’s to pay for daily expenses. This change affects anyone who had an RMD due in 2020 from their 401(k), IRA, and other retirement accounts. The IRS takes the value of your account in December of the year prior. In this case the stock market of December 2019 was considerably higher than it is now. Over the past few months the Dow Jones has declined by over $4000. In a normal year you would be forced to take the RMD on the value of the account as determined at the end of the previous year. The problem now is that this means the IRS is essentially forcing you to sell low. Even if you don’t need the money at this point in time, you will no longer be able to benefit from the tax-deferred nature of your IRA and will now have to start paying 1099’s on any growth you experience. The last time this was done was in 2009 after the collateralized mortgage debt crisis. Sidenote: We went from $24 trillion to $25 trillion in debt in a little over a month. In one year we may be up another $4-$5 trillion in debt. We are accumulating debt at breakneck speed which means the low tax rates we are enjoying right now are all the more a good deal. When you take an RMD, you have to put it into your taxable bucket. You do not have the luxury of converting it to a Roth IRA, but this year you now have the ability to put it into your tax-free bucket instead of with a Roth conversion. This won’t make a huge difference in your finances overall but every little bit helps as we move into a period in history where tax rates are going to be dramatically higher than they are today. Keep in mind that Roth conversions can no longer be undone, so you must be confident that the tax rate you are paying right now is lower than it will be in the future. The only downside is that for people that need the funds to sustain their lifestyle will not be able to take advantage of this situation. We have six years to take advantage of historically low tax rates and this is a nice opportunity for the 20% of America that doesn’t need those RMD’s and can take advantage of a Roth conversion. Another advantage is that because the stock market is currently down you are going to be paying taxes on a lower amount. Let’s pay that lower amount and get the rest into the tax-free bucket to let it recover and compound. There is an opportunity for those that don’t require their RMD, but they have to take advantage of it by taking action now.

Can you be in the 0% tax bracket and still be a good citizen?’ is a common question that David gets fairly frequently. David relates an exchange he had with a listener on Facebook where they stated that paying less taxes is inherently selfish and paying taxes is how we take care of people as a society. Most people have the thought of “what happens to society if everyone is in the 0% tax bracket?” The trouble is they are coming at the question from the wrong angle. Everyone who earns an income will be paying income tax. The only way to not pay taxes is to not be working and basically be in poverty, the income you earn is below your standard deduction, or you’re retired and have done all the heavy lifting of positioning your money to tax-free. Are we in danger of having 78 million Baby Boomers being in the 0% tax bracket? Not really, at this point, there is still $23 trillion in the cumulative IRA’s and 401(k)’s in the country and only about $800 billion in the Roth IRA’s and Roth 401(k)’s, which is about a 25:1 ratio. Even when people do hear the message of the Power of Zero paradigm they don’t always act on it. Even though people believe that tax rates are going to be higher in the future, they are not doing anything about it. There is an incongruency between what they believe and what they do. That means we are marching into a future where tax rates are going to be higher than they are today and advisors have a lot of heavy lifting to do to get the message out. “Over and over again the courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike, and all do right for nobody owes any public duty to pay more than the law demands.” -Judge Learned Hand The tax code actually encourages us to pay as little taxes as possible. David uses the analogy of a toll road and the question of using a different route. The question comes down to when you are paying the taxes, not if you are paying taxes. You can either pay taxes now at historically low rates or you can postpone the payment of those taxes until the future when taxes are likely to be much higher. People can feel perfectly guilt-free for taking advantage of tax rates while they are low. There is simply nothing wrong with appreciating the fiscal landscape of our country and that a revenue-hungry federal government is going to have to pay for their bills one way or another. It is perfectly moral to keep as much money that you have earned and saved within your own pockets as you can. You are completely within your rights to pay your taxes today while they are historically low instead of waiting until the tax sale is over in 2026.   Mentioned in this episode:https://www.amazon.com/Tax-Free-Income-Life-Step-Step/dp/0593327756/ref=s_nodl

Families that aren’t quite rich enough to be affected by the Estate Tax, but have built wealth over time, have another benefit available to them called the step-up-basis loophole. Essentially, what happens with the step-up-basis loophole is when you pass on an investment to your beneficiaries, the present value at the time of your death becomes the new basis for that investment. This will wipe out the capital gains on that investment and can be a great deal which compares favourably to inheriting a Roth 401(k). Anything over $23.16 million in your estate will be subject to a punitive estate tax of 40% when you die. But if you have an estate that is worth less than $23.16 million in your taxable bucket, that money can go tax-free to the next generation. What happens to loopholes as time wears on? They become the target of a revenue-starved federal government. There are four reasons why, while this may sound like it compares favorably with a Roth IRA, it is not the best idea. If you receive dividends from one of your investments, even if you reinvest them back into the stock, you are going to have to pay tax on them which can stymie the growth of your stock portfolio. Because you have to pay tax on those dividends, you are exposed to tax rate risk along the way. Should taxes raise dramatically over time, so will the taxes on those dividends. You also have to remember those dividends count as provisional income which could affect your social security. The step-up-basis loophole is also going to come under fire as the country slides into insolvency and the government’s national debt starts to skyrocket. Joe Biden is currently proposing that the step-up-basis loophole be closed, which would mean that you would inherit the original basis of the investment. This would also mean that you would have to pay long-term capital gains on the difference. If you have an annual income greater than a million dollars, you would be required to pay the difference between the basis and the current value at your highest marginal tax bracket, which means you will be paying very close to the 40% estate tax that you wouldn’t otherwise be subject to. Big taxes are coming down the road and letting your stocks grow in your taxable bucket will be a bad idea. Lawmakers have their sights on the step-up-basis loophole in the near future. Some people believe the current tax law is even better than the Roth IRA because you won’t have the same requirement of spending the money down over the next ten years. If you are building your financial plan around this loophole being around for the next 10 to 15 years from now, you’re going to be disappointed. We have to start looking at the four to six different streams of tax-free income for retirement. Life insurance has been around forever and like the loophole we are discussing, it allows you to pass money onto the next generation tax-free but won’t be in danger of being eliminated. Make sure that you are maxing out your Roth 401(k)’s, Roth IRA’s, taking advantage of Roth Conversions, and funding your LIRPs. These are all things that are going to be immune from the tax changes coming down the pipe. We are going to be looking at higher tax rates in the future, Republican or Democrat, it doesn’t matter. It's just a question of time before the loophole is closed so we have to start planning with the expectation that it won’t be around when we die.