The Power Of Zero Show

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.

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.