The Power Of Zero Show

The SECURE Act was passed a couple of weeks ago and we now know what it's implications are. The big thing that everyone is talking about is that it eliminates the lifetime stretch provision for non-spouse beneficiaries of IRA's, 201(k)'s, and Roth IRA's. Now, if you're leaving your IRA to a non-spouse beneficiary like a child, they will have to realize it as income over the following ten years. If your child will inherit your IRA, they will probably do so when they are at the apex of their earning years. The question is if this happens 20 years from now, will tax rates be higher or lower than they are today? That money will be piled on top of all their other income and they will be taxed at their marginal income. This is a backdoor tax increase. This is a money grab by the IRS unless you do something about it. This even applies to Roth IRA's. If that money gets distributed over the next ten years, it will probably end up in a taxable account that the IRS will start earning money on. If you have an IRA, you need to ask yourself if you will have significant amounts of money in those accounts at the end of your life and might they go to a non-spouse beneficiary. This underscores the importance of doing Roth conversions during your lifetime. If you have a large IRA and plan on leaving it to the next generation, you need to consider what taxes will look like in the future. There has been a new estimate that the SECURE Act will generate $15.7 billion in tax revenue over the next decade. The implications for retirees will be largely positive, but the heart of the law is about forcing people to pay higher taxes in the short term. When these beneficiaries inherit these accounts, they will be forced to realize the income whether they need it or not. Once they pay the taxes, they will have to put the money somewhere and the question will be where do they put it. Traditional tax-free options like a Roth IRA are too prohibitive so it will likely end up in the taxable bucket, where the IRA will benefit once again. This is where the L.I.R.P. comes into play. It's an optional place to put the money that comes with a number of additional benefits. This makes an even more compelling case for people who were still on the fence. They now also have to consider if they want their beneficiaries paying up to half the inheritance in taxes. This is an opportunity to start doing some tax planning, we still have six years to stretch out our tax liabilities if we act now. The other big change coming with the SECURE Act is the required minimum distribution age going from 70½ to 72. 80% of Americans with RMD's are taking more than they need to anyways so this won't impact them too much. The last change allows people to do backdoor Roth conversions after the age of 70½. The big question that people now have to ask themselves is "do you think you will have money left over in your IRA when you die?" Because if you will, do you really want to have scrimped and saved for your entire life only to have your beneficiaries pay half the amount in taxes? We need to be taking advantage of the next six years. Don't wait to only pay taxes at much higher rates because at that point, the sale will be over.

One of the most common questions that David gets is regarding what happens to the Medicare Part B premium if someone engages in a Power of Zero tax strategy. Are there unexpected consequences of shifting money from tax-deferred to tax-free? When you do a Roth conversion, it doesn't count towards the income thresholds that determine whether you can do a traditional Roth IRA, but it does have an impact on your Part B Medicare premium as well as your prescription drug premium. IRMAA stands for income-related monthly adjustment amount and it's basically a higher premium charged by Medicare Part B and D to individuals that reach certain thresholds. Medicare Part B helps pay for certain services like outpatient care and for the average American they pay 75% of the Part B premium. If you are taking advantage of the 22% and 24% tax brackets you are going to move through two different thresholds when it comes to IRMAA and could be looking at an additional $2000 in costs per year when doing Roth conversions. At the top of the 24% tax bracket, it could be a little over $3000. The thing to keep in mind is you're only paying this extra premium in the years that your income goes up due to the Roth conversions, it doesn't mean your premiums will stay that way forever. The question then becomes "is the increase in premium worth it?" The simple way to find out is to do the math. If tax rates are going to double in the future, will those taxes be more or less than the two to three thousand dollars in increased premiums you're going to pay now? You can also just compare the cost to the tax rate increases coming in 2026. You'll probably find that your tax rate will still be more than the increase in your premiums. When you get money shifted at historically low tax rates to avoid a doubling of tax rates over time, but you have to pay a little bit extra, you're still much better off. Pay the higher drug premium now and avoid the tax freight train that is bearing down on your retirement.

Once you get past December 31 of 2019 you will only have six years left to reposition dollars from tax-deferred to tax-free before tax rates go up for good. Every year that goes by your timeline gets shorter. The question that David gets all the time is what is going to happen once 2026 hits and will the Power of Zero paradigm still exist? The Power of Zero was written in 2013 and plenty of people between 2014 and 2017 were taking advantage of the Power of Zero strategy before they even knew there was going to be a tax sale. Even back then those tax rates were still considered good deals. Just because the tax sale ends in 2025, that doesn't mean things are changing that much. Tax rates will still be low historically and especially so given where tax rates are likely to go in the next decade or so. The main thrust of the Power of Zero message is that in a rising tax rate environment there is an ideal amount of money to have in your taxable and tax-deferred buckets. So long as you are paying taxes that are lower today than they will be in the future the strategy still applies. The difference between the low tax rate and the high tax rate is a benefit that accrues to us and helps us wring more efficiency out of our tax dollars. The question you need to ask yourself is "are we in a rising tax rate environment?" The Power of Zero vision is always in effect in a rising tax rate environment, the only scenario where it doesn't make sense is in an environment where taxes will be lower in the future than they are today. What if you only have two years left? If you're going to shift all your money in two years, you have to be very cognizant of what tax bracket you will bump into. In many situations, it will make more sense to pay slightly higher taxes by stretching out your plan beyond 2026. There are worse things than paying a few extra percentage points in taxes. Even while taxes are on sale, you don't want to rise into a tax bracket that you wouldn't otherwise have to. If you average the tax rates during the tax sale with those few years you may have to pay beyond 2026, you are still probably coming out ahead than if you had shifted all your money prior to 2018. It's not the end of the world when we get to 2026. The Power of Zero paradigm will still be in full force. Simply put, in a rising tax rate environment you are always going to be better off paying taxes at the lower rate. Don't panic if you only have 5 years to get all your shifting done. What should worry you is waiting until 2027 and beyond to start the process. All tax rates have to do in the future is to rise by 1% a year for the Power of Zero math to make sense.

The last weeks of December are critical in terms of taking advantage of your last opportunities to do Roth conversions for the 2019 tax year. Many people think you can go all the way until December 31 but that's not always going to be the case. Some companies require you to submit a Roth conversion much earlier because they can take some time to process. Missing the Roth conversion deadline can have major tax implications. With a traditional IRA you can fund it up until April 15 of the following year, but that's not the case with Roth conversions. They have to be done by December 31 of the current year which can cause some people problems because of the tax uncertainties involved. The IRS no longer allows you to do Roth recharacterizations in the event you end up in a higher tax bracket than expected. You just have to give it your best estimate. You should be doing a Roth conversion in 2019 because if you don't, you no longer have seven years to stretch out your tax liability. If you waited until you had only a single year to do your Roth conversions and convert a million dollars, most of that money will be taxed at 37% plus whatever your state tax happens to be, and it will happen all in one year. This means you could give away up to 45% away. The whole idea of this planning is to reduce taxes as much as possible and avoid a doubling of tax rates over time. Even if you take two years to complete your Roth conversions, you're still likely going to be in the 37% tax bracket. The further you stretch out your Roth conversion, the lower the effective tax rate on that conversion. If you feel like tax rates are going to be higher in the future than they are today then every year counts. There are worse things in the world than simply paying the taxes at what the rates will be in 2026. What you should worry about is what is going to happen beyond that when we get to a crisis point in our country financially. There is a proposal going through the House of Representatives right now that could result in an additional 7% increase in taxes for most Americans. The tax rates in 2026 may still be good deals of historic proportions because at the rate we are taxing Americans right now, there is just not enough money to pay for everything that's been promised. Every percentage point increase in taxes after you retire means less money for you to spend. Remember, it's not how much you have, it's how much you actually get to spend after tax. It's crunch time. If you're going to do a Roth conversion this year, now is the time to act. Take advantage of the seven years you have and keep more of your money. Go to davidmcknight.com and find out what your Magic Number is. Keep in mind that you want to have some money in your tax-deferred bucket to take advantage of your standard deduction. The 22% tax brackets for most Americans is golden. These tax brackets are not going to be around forever. If you wait even only a little bit you may miss your chance this year.

David gets a number of emails from listeners saying that he's been wrong for years and the central thesis of the Power of Zero paradigm is incorrect. The question is, do the tax cuts of 2016 delegitimize what he and others have been saying? In reality, the problem has only compounded since the tax cuts came into effect. You have to consider whether the US government is prone to making bad financial decisions and has just kicked the can further down the road. David Walker says that anytime you have tax cuts, they should be accompanied by a commensurate decrease in spending. The Republican Congressional Budget Office says that the tax cuts will cost $1.5 trillion over the next ten years. Notice what's happened to the deficit. Since the tax cuts have been put in place, the deficit has only gone up. When we get to the point where we have trillion dollar deficits, that's the canary in the coal mine for a sovereign debt crisis. If anything, we have just covered up the problem and deferred it into the future, but in the process have made the reality of future tax hikes all the more inevitable. What happens if we don't increase revenue or cut spending? We will get to a crisis point where we will have to have immediate and dramatic increases in taxes just to pay for social services. The federal government has a history of waiting until the very last minute to address these problems. Just because the government behaves irresponsibly, that doesn't mean the math to which David Walker and other economists refer doesn't add up. Every year that goes by where the government fails to reduce spending, spending reduces its effectiveness. We will get to a point where the interest on our debt consumes such a large part of the budget that we won't be able to pay out Social Security and Medicare benefits without raising taxes. We are financing our spending with debt, and eventually the interest on that debt will become so prohibitive that it will crowd all the other expenses out of the budget. Has the central thesis been disproven? Of course not! If anything, the tax cuts have made the Power of Zero paradigm more important. Every day that goes by where the federal government fails to reduce spending means the reality of higher taxes down the road becomes all the more imminent.

When someone is talking about a risk multiplier, they are essentially talking about longevity risk. The longer you live, the more likely it is for you to experience a subset of risks that could completely derail your retirement plan. There first major risk is the long term care risk. In many ways, you are better off dying than needing long term care, because a long term care event can completely decimate your savings and put your spouse into a very difficult spot. Historically, long term care policies are how people have mitigated this risk, but these policies have a number of disadvantages. They tend to get more expensive over time, often to prohibitive levels, and it can be very difficult to qualify. People also find the chance of paying for a long term care policy but never using it pretty irritating. Insurance companies started exploring the idea of giving people their death benefit in advance of their death in the event of a long term care event. This puts people in the scenario where if they die peacefully in their sleep their beneficiaries will get the death benefit completely tax free. This is why the L.I.R.P. is the recommended way of dealing with the risk of a long term care event. The second major risk is withdrawal rate risk. This risk basically says that there is an ideal amount of money to take out of your stock portfolio each year to avoid running out of money. The previous rule of thumb used to be withdrawing 5%, but that was found to be generally too risky. The current recommendation is somewhere closer to 4%. The sequence of return risk is closely related to withdrawal rate risk. If you are withdrawing money during a down market in the first ten years of retirement, you could send your portfolio into a death spiral where it never recovers. Combined with withdrawal rate risk, sequence of return risk can really mess with your retirement plan. The Wall Street Journal is saying the 4% rule is now actually the 3% rule if you want to mitigate your risk. To shield yourself from sequence of return risk and withdrawal rate risk, to fully mitigate them you need to have a massive amount of money saved by the time you get to retirement. There is another way to mitigate this risk without accumulating a giant amount of money and that is through a guaranteed form of income through an annuity. If you have a pension from your work or are a fan of social security, you are also a fan of annuities because they operate on the very same premise. If you're going to live a 40-year retirement instead of a 5-year retirement, then you are much more likely to run into these risks. Take a portion of your stock portfolio and give it to a company that pools your risk with other people's risk in exchange for a guaranteed stream of income until you die. In the case of a down year, you can avoid taking money out of your portfolio and rely on the annuity instead. The answer to the three basic risks in retirement are having an L.I.R.P. and an annuity. Mathematically speaking, your money lasts longer, you're able to spend more money in retirement, you're able to effectively mitigate longevity risk by having some guarantees in your portfolio. Longevity risk is the risk multiplier, it will make the other subsets of risks even more likely to derail your retirement. If you want to eliminate stress from your retirement and have peace of mind, then pooling risk and offloading it to insurance companies is the way to do it.

David is generally very reluctant to recommend something that would cause someone to bump from a 12% tax bracket into a 22% tax bracket. We're trying to avoid the tax apocalypse that's coming down the road, and that means thinking about the future. There are some circumstances where it makes sense though. A scenario to compare is between two 65 year olds with similar amounts of money in their three buckets. The first thing to do is figure out what their taxable income is by crunching the numbers on the income from their pensions and other sources, as well as their standard deductions. In this scenario, both people are in the 12% tax bracket, which is great for them. The 12% tax bracket will be looked back upon as the deal of the century. But we have to acknowledge the remaining $700,000 in their tax-deferred bucket and they only have $24,000 left before they hit the top of the 12% tax bracket. We could shift some of their money from tax-deferred to tax-free each year to keep them in the 12% tax bracket, but would that really solve anything? How big will their IRAs be once they turn 70 and a half, when they are forced to take the money out? There may be a scenario where it makes sense to go into the 22% tax bracket. We have to project into the future and see how big their required minimum distributions will be in a few years. At that point in time, the 22% tax bracket will be reverting back to the 25% tax bracket, and we may very well see that the 22% was actually a good deal. We also have to recognize that there is a scenario where someone can be bumped into the 22% tax bracket overnight. If you're over 65 and your spouse dies, you will find yourself in the single filer tax bracket and your thresholds are reduced considerably. It's a penalty to be single in many ways since your tax bracket gets cut in half. The third scenario to consider is the effect of the upcoming SECURE Act. Starting next year, it could force a non-spouse beneficiary to spend down an inherited IRA or 401(k) over the course of ten years. This could mean that your beneficiaries could inherit your money at the apex of their earning years, at a period of time when taxes are going to be higher than they are today, and when they can least afford to pay the higher taxes. If you are afraid of the 22% tax bracket right now, your children could be paying tax on your money at the 32% or 35% tax bracket, or the future equivalent. Whereas you could have paid the 22% tax now and allowed them to receive the money in the future tax-free. Consider the three circumstances where it may make sense for you to bump yourself into the 22% tax bracket. If you find yourself as a widow prematurely, you could find yourself spending a fair amount of time in the single filer tax cylinder. If the SECURE Act gets legislated into law, your children will inherit your money and end up paying a much greater amount of taxes.

Rule #1: Everyone's situation is different, and there is no cookie cutter approach. You can't pick up the Power of Zero book and have the exact recipe for success. It will need to be tailored to your personal situation. Rule #2: It is unlikely that you will be in a lower tax bracket in retirement. The closer you are to 2029, the less likely you are to be in a lower tax bracket. We know when the tax cuts will end and when tax rates will go up. When you look at the ten-year horizon, it's really tough to make the case that tax rates won't be higher. This turns conventional wisdom on its ear. We are marching into an uncertain future, and that doesn't bode well for people that have the majority of their money in the tax-deferred bucket. Rule #3: There is an ideal balance to have in your first two buckets in a rising tax rate environment. Your taxable bucket should contain around six months worth of expenses and your tax deferred bucket balance should be low enough that RMD's are equal to or less than your standard deduction, as well as not cause social security taxation. Rule #4: Anything above and beyond the ideal balance in those first two buckets should be systematically repositioned to tax-free. Preferably you don't do it all at once but you do it quick enough to get all the heavy lifting done by 2026. Rule #5: Anything with the word Roth on it is your best friend. These vehicles give you the ability to shift nearly unlimited money from tax deferred to tax-free. Rule #6: Social security taxation is a big deal and you should do everything you can to get your social security tax-free. If your social security is taxed, you will have to spend down all your other assets even faster. In many cases, your money will run out five to seven years faster if your social security is taxed. Rule #7: The best way to deal with long-term care in retirement is not through a traditional long-term care policy. An L.I.R.P. is a much better option. If you die peacefully in your sleep never having used the long-term care, at least someone is still getting a death benefit at the end. L.I.R.P.'s are great way to take the sting out of mitigating the long-term care risk. Rule #8: You will need more than one stream of tax-free income in retirement. You never know when the IRS is going to legislate one of your tax-free streams of income out of existence. You need multiple streams of tax-free income working together. Rule #9: You really want to get all your heavy lifting done before 2026. You have seven years before the tax cuts end and every year you wait to take advantage of these low tax rates, is another year you will have to pay more than you need to. Rule #10: Know your magic number. Your magic number is how much you should be shifting each year from tax deferred to tax-free so that by 2026 everything is perfectly allocated. You only have so many retirement dollars, so you need to spend them in the most tax efficient way possible. Rule #11: Never, ever annuitize your retirement in the tax deferred bucket. Annuities in your tax deferred bucket will count as provisional income and cause you all sorts of problems. When you annuitize your investment, there is no going back. Rule #12: It is much better to have a guiding hand when you're navigating the path to the zero percent tax bracket. The thresholds are always changing and there are a number of ways to get it wrong. Connect with a certified Power of Zero specialist who can help you avoid the pitfalls.

When David is working with a client, his recommendation is to reach the zero percent tax bracket is by having 5 to 7 streams of tax-free income. These can include Roth IRA's, Roth 401(k)'s, and L.I.R.P.'s. David often asks advisors what they think is his favorite. Rarely, will anyone guess the truth is RMD's (Required Minimum Distributions). The holy grail of financial planning is any investment that gives you a tax deduction on the front, grows tax-deferred, and you can take it out tax-free. A Health Savings Account and an IRA or 401(k) that allows you to get a deduction on the front end, grow the money tax-deferred, and then allows you to take a portion of the money out tax-free are two of the few vehicles that tick all the boxes. You want a balance in your 401(k) that's low enough that it's equal to or lower than your standard deduction and doesn't cause social security taxation. You can use the calculators on davidmcknight.com to figure out your number. You can also learn your magic number, the amount of money you need to shift each year to achieve your ideal balance. Your IRA and 401(k) only becomes the holy grail of financial planning if they have the ideal balance. That's when it becomes tax-deductible on the front end, grow tax-deferred, and the money can be taken out tax-free. If you have a high deductible health care plan, an HSA is a good idea because when you put money in, you get a deduction, and when you take money for a qualified health care purpose, you get it tax-free. If your RMD's are equal to or lower than your standard deduction and don't cause your social security to be taxed, they become the true holy grail of financial planning. If somebody says to you that you should convert everything you have to a Roth IRA, you have to think about what is going to happen your standard deduction in retirement. If everything is in the tax-free bucket your standard deduction will essentially be left idle. There is an opportunity cost of moving too much of your money from tax-deferred to tax-free. If someone recommends a financial plan that only features the L.I.R.P., you need to run the other way. The L.I.R.P. has significant shortfalls and is not the perfect solution, it's only one piece in the puzzle of getting to the zero percent paradigm. The holy grail of financial planning is really about establishing the perfect amount to have your tax-deferred bucket. If your advisor can't tell you what that number is, you're probably not dealing with a Power of Zero advisor. The ideal approach to Power of Zero retirement planning is to call on as many of these streams of tax-free income in retirement as possible. Each account and investment is meant to be a solution to a specific situation and they only complete the picture when put together the correct way. The L.I.R.P. is for addressing the highest risk in retirement, namely a long term care event. In some cases, almost dying can actually be worse than dying by decimating the assets that would normally go to your spouse. Make sure you have lots of different streams of tax-free income, none of which shows up on the IRS's radar but all of which contributes to you being in the zero percent tax bracket. Above all make sure you've got some money left in your tax-deferred bucket so your standard deduction isn't left languishing. Determining the right amount to have in your tax-deferred bucket is critical, in a rising tax rate environment anything above that amount should be shifted over to tax-free.

There are three words that don't get mentioned very much, but they should scare the dickens out of you. Those words are Public Pension Liabilities. It's a problem that is largely flying below the radar, but if you live in a state with a lot of public pension liabilities, it could end up like Detroit. Public pensions often end up swallowing up the state budget until there is little left over to provide basic services. A pension is a guaranteed stream of income that is paid to you either over your lifetime or the life expectancy of you and your spouse. It used to be very popular in the private sector, but they became phased out as they became too expensive. However, they still persist in the public sector. Public pensions are a great way for politicians to get elected. It's very easy to make a promise to perpetuate lavish benefits when they don't have to deal with the consequences for potentially decades down the road. It will get to the point where certain states will go bankrupt because they can't afford to pay the pensions that have been promised. California, one of the fiscally unstable states in the country, has over 62,000 pensioners that are getting over $100,000 per year. Illinois is on the cusp of bankruptcy because of all the unfunded obligations they have in regards to pensions. These public employees deserve competitive pay, but people are living longer and cities are now in a unique position where they have to fund their current budget. However, they also have to pay one or two generations of retirees. When we ask the states to total up their unfunded obligations they say it adds up to $1.4 trillion, but the Federal Reserve and others put that number as high as $5.3 trillion. You have to realize the precarious position that states are in. They can only raise taxes so high before people start fleeing their state. They can't print money, so their budget is limited to what they bring in. They will eventually have to cut services. Some believe the federal government will intervene, but that's not going to play out the way most people believe. We often focus on the broad national debt, but we often forget what's going on at the local level. If the federal government opts to bail out the states, it will be by raising taxes on everyone. There is a storm looming on the horizon. We have to keep in mind that public pension liabilities are a chicken that will come home to roost sooner or later. It won't be the states that go into austerity to be able to deliver on these pensions. You're going to see the federal government intervene and raise taxes to be able to deliver these pensions from the fiscal abyss into which they have descended over the last couple of years. [ There are solutions that states could look at that could potentially fix the problem. Fix number one would be to wean new employees off of pensions so less of the onus is on the state government. [ Politicians love to bend the truth and promise people a lot of free stuff, so they may not be the ones that push a real solution forward. They have to be much more transparent with the price tag associated with what they are promising. [ We can no longer afford to lavish our public sector employees with very expensive guaranteed pensions. There is a big storm on the horizon, but one of the smaller storms that doesn't get talked about enough is the public pension liabilities that are going to be a major issue for a number of states in the near future.