The Power Of Zero Show

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.

Should you be contributing to your Roth 401(k)? The short answer is yes because anything with the word Roth in front of it is truly tax-free. What does it mean to be truly tax-free? Roth 401(k)'s pass both litmus tests for what makes something tax-free. If you're younger than 50, you can put in $19,500 each year, and if you're over the age of 50, you can catch up a bit with an additional $6,500. You can also still get the match when contributing to your Roth 401(k). Your company will put those dollars into your tax-deferred bucket. It's okay to have some money in your tax-deferred bucket because the IRS is going to force you to take money out of that bucket at age 72, but you will be able receive up to a certain amount of money tax-free because of your standard deduction. In many cases, this can mean that you can put pre-tax dollars into your tax-deferred bucket and get a deduction on the front end. It will grow tax-deferred, and you'll be able to take it out tax-free. It's ideal to have multiple streams of tax-free income and Roth 401(k)'s fit into the typical strategy that David recommends to his clients. There is a big difference between Roth 401(k)'s and Roth IRA's. With a Roth 401(k), the IRS will force you to take the required minimum distributions at age 72 for the same reason they force your beneficiaries to withdraw money from an inherited Roth IRA. They want that money going back into circulation so it can be taxed again. The strategy around this is to roll Roth IRA dollars into a Roth 401(k) account, but you have to be aware of the different rules around the Roth 401(k) first. Roth IRA's have a five-year holding period, similar to Roth 401(k)'s, but they function differently. If you don't currently have a Roth IRA, open up one now and start your five-year clock. Keep in mind that any money rolled from a Roth 401(k) into a Roth IRA will still have to contend with the ten-year window your beneficiaries will have to spend down the account when they inherit the money. If you only have enough money to fund your Roth 401(k) up to $26,000 per year but that doesn't leave anything left over for the LIRP, what should you do? You need both, so a good strategy is to put enough into your Roth 401(k) to get the maximum match and the rest into your LIRP. Don't put yourself into a position where it's either/or. Instead, put yourself into a position where you can get the best of both buckets. You should be doing a Roth 401(k), so reach out to your human resources department to add one. Not only will you benefit, but your fellow employees will as well.

Under what circumstances should a single person want to own an LIRP? There are a number of scenarios where it can make sense, but it definitely depends on the individual's situation. We have to remember the primary motivation for having life insurance is having death benefit, but there are a few close second reasons. Using the death benefit in advance of your death to pay for long-term care is one such reason. With sufficient long-term care insurance, you are able to call the shots and have the long-term care performed in your home, which studies have shown also leads to longer life expectancies. Without long-term care as a single person, you will end up spending down all your other assets in order to pay for it until you basically run out of money and end up qualifying for Medicaid, which is not something you really want to qualify for. Medicaid facilities are typically of the government's choosing and there is often a wide disparity in the quality of care you will receive when compared to a facility paid for by your LIRP. Should you find yourself unable to do two of six activities of daily living, the LIRP will allow you to take 25% of your death benefit in advance of your death for the purpose of paying for long term care. More and more people over the age of 50 are getting LIRPs mainly because they want to be able to call their own shots when it comes to long-term care instead of being forced into a Medicaid-funded facility. The second big reason has to do with your IRA. If you want to control how your beneficiaries spend your IRA money, you can't really do it due to the new retirement laws introduced earlier this year. The third reason is you want your money to grow safely and productively. Some LIRPs have a growth account that is linked to the upward growth of a stock market index. If the index were to go out in any given year, your account is credited a zero. Historically, this will net you 5% to 6% after fees. This allows you to use the LIRP as a functional replacement for the bond portion of your portfolio. If you have too much money in your taxable bucket, it may not seem like a big deal until you crunch the numbers on all the inefficiencies and find it can cost you hundreds of thousands of dollars. Many of these benefits of the LIRP are very useful to a single person, but the most important is being able to access your death benefit in order to fund long-term care. Visit the Medicaid-funded facility in your area and see what you think about it and then consider how an LIRP can allow you to ride out a long-term care event in your own home. A lack of income limitations are another important factor in the LIRP that essentially allows a single person with an income greater than what they can put into an IRA access to an unlimited bucket of tax-free dollars. The tax freight train is accelerating due to the Covid-19 stimulus package so be prepared.

David often gets questions from people asking why they would want to liquify their investment portfolio to fund their annuity, especially now with the markets being down due to the coronavirus. There is an inverse relationship between stocks and bonds, when stocks are down bonds are up. Annuities and the LIRP share a lot of similarities and effectively replace the bond portion of a portfolio. Annuities can be superior to bonds for seniors, giving them high, guaranteed payments for the rest of their lives that allows them to be more aggressive with the rest of their portfolio. Basically, an annuity that guarantees a stream of income for your lifetime functions like the bond portion of your portfolio. If the stock portion of your portfolio is down, that means that the bond portion is up. If you want to guarantee a portion of your income, it may make sense to simply replace the bond portion of your portfolio with an annuity. Once you start drawing income from the annuity it continues to function as the bond portion of your portfolio and in many cases because of the growth mechanism internal to the annuity gives it the opportunity to keep up with inflation over time as well. If you just qualified for a LIRP, you may have the same question in your mind. Why do it now while the stock market is down due to the coronavirus? The key to remember is that you won't be cementing your losses in the stock portion of your portfolio, you fund it through the bond portion which happens to be doing great right now. When the stock market recovers, the stock portion of your portfolio will grow along with it. Now is an excellent time to start repositioning money to tax-free. Every year is a window of opportunity to take advantage of historically low taxes. You can also take advantage of the cost of a Roth conversion based on the depressed value of your assets. If you're concerned about the losses in your portfolio, you have to remember that the LIRP and annuities are designed to replace the bond portion of your portfolio, not the whole thing. They actually reduce the overall risk in your stock market portfolio while giving you higher rates of return. Don't wait for the stock market to recover, just think of an annuity as a more effective and efficient bond and if you're over the age of 50, the LIRP is also a heartburn-free way of mitigating long term care risk. Retirement economists are unifying their voices and saying that your stock market portfolio will last longer if you guarantee a portion of your retirement income.

Investors need to understand the latest coronavirus stimulus bill that was just passed. Investors can now take out up to $100,000 from their 401(k) or IRA prior to age 59 and a half without any penalty. The bill has also increased the loan size you can take out from your 401(k) to $100,000. Another big piece of news investors should be aware of is that required minimum distributions are going to be waived for 2020. The question is how will the IRS fill the hole in the federal government's revenue for the year. This coronavirus bill is twice as large as the previous economic stimulus bill in the wake of the 2008 mortgage crisis. This is the single largest stimulus bill in the history of the world. A quick breakdown of where the $2.2 trillion will be spent over the next few months. Stimulus checks will be sent out. Individuals who make up to $75,000 per year will receive a $1200 check from the government. Couples who make up to $150,000 per year will receive a $2400 check. For individuals who make more than those thresholds, they will gradually reduce the amount of money being sent out. Additionally, parents will receive an additional $500 per child. People that have their automatic bank deposit info on file with the IRS will receive their money in the next two to three weeks, those that don't will be mailed a check but who knows when that will occur. There is already a push for another stimulus bill beyond the first, specifically with pressure from Nancy Pelosi, that aims to increase the benefits for food stamps, increase the amount of money going to regular Americans, and introduces some environmental restrictions on airlines. There is a lot more spending and money printing/borrowing coming down the line, including a plan for the US Treasury to mint two $1 trillion coins and deposit them in the Federal Reserve. This is essentially an exercise in playing around with Monopoly money. There are universal financial laws at play here, and when you violate them there is always a chicken that comes home to roost. Money is valuable because it is scarce and creating more makes it less valuable and precipitates inflation or hyperinflation. According to the New York Times, the stimulus is going to be financed by borrowing money. When asked how the government is going to pay for this additional spending, they claim that they will actually be reducing taxes on top of the spending. There is always an unintended consequence of printing or borrowing money. This increase in spending will accelerate everything that we've been talking about on the podcast and that includes massive inflation. Countries will likely stop loaning the US money unless we raise interest rates in the near future. Low-interest rates mean the loan is riskier for those countries so they are less likely to make them. Increasing interest rates will only make servicing the existing debt that much harder and will likely lead to a financial crisis much sooner than would have otherwise happened. 2030 will be a year of massive consequences for the US, and this stimulus bill may even bump that up to 2029 or 2028. We are essentially running a deficit of $3 trillion this year and that will have major consequences for the economy going forward. This is only emphasizing how important the Power of Zero paradigm is for your retirement.

The coronavirus downturn in the market is actually the perfect time to do a Roth Conversion because of the double sale that's going on. The first sale involves the next six years where we get to enjoy the lowest tax rates we are likely to see in our lifetimes. The second sale is due to the 35% drop in the stock market, your assets are now at much lower values and that means the tax on a potential Roth Conversion is also 35% lower. If you were to hypothetically convert a $1 million IRA this year your tax bill would be approximately $299,112 or a 29% effective tax rate. If you take in the decline in the stock market of 35% your tax bill is a little more than half. If the stock market goes through a massive recovery over the next few years having done this Roth Conversion, all of that recovery occurs in your tax-free bucket. If the market is down 25%, your portfolio has to recover 33% to get back to where you started. If the market drops 50%, you need a 100% recovery to get back to even. Where would you prefer to have that recovery occur, in your tax-deferred bucket or your tax-free? You have the opportunity to take advantage of a double tax sale right now. Your assets are 35% lower than they were about a month ago and that means the cost of getting into the tax-free bucket is on sale right now as well. There are a couple of caveats to be aware of. If you decide to undertake a Roth Conversion right now and don't have the tax withheld by your custodian, you don't want to delay paying the tax because you will end up paying penalties and fees. No matter your age, the very best place to pay for the taxes of a Roth Conversion is out of your taxable bucket. If you have more than six months worth of expenses in your taxable bucket you have some inherent tax inefficiencies in your portfolio that can cost you hundreds of thousands of dollars over your lifetime. Let's use our least efficient bucket to help move money into our most efficient bucket. When you contribute to a Roth IRA you have to use cash. That can be problematic because there can be lots of movement in the market when you liquify parts of your portfolio. You can't predict what is going to happen with the market which is why the Roth conversion is so useful. The Roth Conversion allows you to do a like-kind transfer where you can transfer shares you own from one account to a Roth IRA. This insulates you from the rise and fall of prices while you cash out from the market. If you want to get into the zero percent tax bracket, you have a huge opportunity right now. The market will likely recover at some point in the future, and that means there are a number of great deals to be had right now. Ideally, your assets will be able to recover in the tax-free bucket and there is a big opportunity to do so in this market downturn.

A common question that David gets fairly frequently is whether or not the LIRP can be a substitute for the bond portion of a portfolio. A lot of people are funding their LIRP's out of stock market portfolios that are growing at an average rate of 8%. If that's the case and they take money out of that portfolio to get a 4% return in their LIRP, doesn't that neutralize the tax benefit that justifies doing the LIRP in the first place? It can make sense for the LIRP to function as the bond portion of your portfolio, so long as you are actually funding your LIRP out of the bond portion of your portfolio! Due to the recent precipitous drop in the stock market this question is popping up more often, but the stock market may be down but the bond market is not down nearly as much. Back in 2008, both the stock and the bond market went down at the same time. In that situation taking some money to fund a LIRP makes sense. You have to recognize that if you are funding your LIRP out of your retirement portfolio, it makes sense to liquidate the bonds when the markets are down to fund your LIRP. This could also hold true with a fixed index annuity. If you're transitioning money from the bond portion of your portfolio to your LIRP, you should take a little more risk in the stock market in the meantime because a LIRP is typically less risky than the average bond portion of your portfolio. If you are barely retired, most of the money you are planning on spending in retirement has even been earned yet. If you want your money to last as long as you do, you need to continue to grow that money over the course of your retirement. If you take money out of your stock market portfolio during the first ten years of retirement you are exposing yourself to the sequence of return risk and if it's done during some down years it could send your portfolio into a death spiral from which it will never recover. Having two to three years' worth of lifestyle expenses in your LIRP is how you want to cover expenses during the two or three down years you are likely to experience in the first ten years of retirement. If you're just retiring now, you're going to have to fund it over the next five or six years and let it sit. You don't want to touch the money until the eleventh year, there are some fees and expenses involved in the first ten years and it doesn't make sense to tap into yet. If you don't have a funded LIRP that can cover the first ten years of retirement, your best bet is to have your lifestyle needs allocated to a time segmented portfolio. The reality is that the LIRP can certainly replace the bond portion of your portfolio. Annuities are great because they can function as the best kind of bond, with higher rates of return and less risk, and can also allow you to take more risk in the rest of your stock market portfolio. As you are transitioning your money to your LIRP from the stock market portfolio and as long as you are increasing the risk in the stock market allocation, you are likely going to get a higher rate of return with less risk overall. You have to grow your money in retirement, this is not the time to go into hibernation mode.