December 12, 2018 David McKnight
The Power of Zero vs. White Coat Investor: David McKnight’s Response

When you google David McKnight or The Power of Zero, the 6th or 7th result in the google search is a blog post from White Coat Investor entitled “David McKnight Scam”. This blog post is a wildly uninformed take on the zero tax paradigm by a former doctor who is rabidly opposed to all cash value life insurance. He is very articulate, knows his stuff and wields a poison pen. Knowing there’s a chance your client or prospect could google The Power of Zero before reading it, you should be prepared to offer counter arguments to each of the points he makes in this blog.  I hope today’s blog post goes a long way towards helping you mount a vigorous defense of the Power of Zero paradigm. His comments are in italics while mine are in non-italics.

Since 2014, The Power of Zero has sold over 200,000 copies, been updated and revised through Penguin Random House where it was the #2 most sold business book in the world the week of Sept. 4th, 2018 and spawned a documentary starring 6-time PBS host Ed Slott, Utah Gov. Gary Herbert, Hon. George Schulz, Hon. David Walker, Larry Kotlikoff, PhD, and a dozen other PhD’s from the most prestigious universities across the country.  The Power of Zero has consistently been a top 10 retirement book on Amazon since it was first published four years ago. These sales are almost exclusively to people outside of my industry as those within the industry don’t buy their copies from Amazon, they buy them from my personal site with bulk discounts.  All this is to say that the American public has voted with their wallets and determined there is something valuable about the message in this book. Over the years I’ve been confronted by a number of naysayers and have thoughtfully considered their criticisms. However, I have seven children and a very busy travel schedule so I don’t always have time to publicly rebut their perspectives. When someone writes a blogpost with my name and ‘scam’ in the headline it impugns my integrity and I feel compelled to respond.  What follows is a point-by-point response to the original blogpost.

There’s a book out recently by a “financial strategist” whose background is in insurance that advocates trying to avoid paying any taxes in retirement.  This is actually possible to do.  You basically only have enough money in traditional IRAs/401(k)s that it can be withdrawn in the 0% tax bracket (up to around $20K a year this year for a married couple taking the standard deduction).  With little other income, Social Security is tax-free. Withdrawals from Roth IRAs are, of course, tax free. If you’re in the 15% bracket or lower, long term capital gains and dividends from taxable accounts are also tax-free.  Muni bond yields are also tax-free.  None of this is earned income, so you don’t pay any payroll taxes on any of it. Those who push strategies like this also tend to sell cash value life insurance, so they like to point out that loans from the cash value of your life insurance policies are also tax-free (although they don’t mention as often that the loans aren’t interest free.)  So, the strategy is minimal tax-deferred money, very tax-efficient taxable accounts, cash value life insurance, and a lot of Roth money through contributions to Roth IRAs, Roth 401Ks, and Roth conversions.  I think the strategy is ill-advised for several reasons.

I’m not sure if the White Coat Investor (WCI) bothered to read the book or investigate my background, but I’ve been a comprehensive financial advisor since 1997.  I hold a series 6, 63, 65, and 7.  I also hold my life and health licenses.  It’s always interesting how someone can read The Power of Zero, only one chapter of which is dedicated to cash value life insurance, and reflexively conclude that I’m an insurance agent or I specialize in life insurance. A cursory glance at the book reveals that a typical Power of Zero recommendation might include Roth IRAs, Roth 401k’s, Roth Conversions, distributions from IRAs up to standard deductions, and yes, in some cases, when it’s appropriate, cash value life insurance, but primarily for long-term care planning purposes (but not always).

I have, conversely, researched WCI’s background and have learned he is an emergency physician whose advice is generally tailored to doctors and dentists, most of whom in 2018 fall into the 32%, 35% or 37% brackets.  The Power of Zero’s intended audience, in contrast, is those who primarily fall into the 22 or 24% marginal tax rates, as demonstrated in multiple examples throughout the book. I was puzzled to see WCI repeatedly characterize the strategies in my book as inappropriate for high-earning doctors and dentists as if they were the primary audience for my book. Could those high earners be in even higher tax brackets in retirement should taxes rise dramatically as many experts claim?  Very possibly, but that’s not the focus of the book.



Tax Fear Mongering

The first problem I have with people advocating for this is that they do a lot of fear mongering. They like to say things like “Tax rates have never been this low so they’re sure to go up in the future.”  Well, tax rates aren’t actually the lowest they have ever been.  You may have noticed the increase in tax rates the last 5 years or so under the Obama Administration, but if you haven’t, check out this link.  The chart demonstrates that our lowest tax bracket has been both lower and higher than it currently is, that our highest tax bracket has been both lower and higher than it currently is, and that our average effective tax rate has been both lower and higher than it currently is (and remarkably stable, to boot).  In addition, capital gains/dividend tax rates have been both higher and lower than they are now.  There is absolutely nothing that is particularly different about tax rates now vs what they have been in the past.  Tax rates do change with the political winds, but if all you’re looking at is the historical data, it would seem just as likely that tax rates are going to go down as up.  That argument is pretty easy to refute.

This argument is not, in fact, easy to refute.  It is not an overstatement to say that effective tax rates between now and 2026 will be the lowest we’ll see in our lifetime. In the documentary, The Power of Zero: The Tax Train Is Coming, we interviewed experts from across the country about the future of tax rates.  Here’s the interesting thing—they were all looking at the same data and they all seemed to agree that taxes in the future are going to be dramatically higher than they are today.  A handful of PhD’s even predicted that tax rates would double.  Among the experts we interviewed were Martin Eichenbaum PhD, NorthWestern; Larry Kotlikoff, PhD Boston University; Hon. George Schulz, Hoover Institution at Stanford; Nada Eissa, PhD Georgtown University, Alan Auerbach, PhD Berkeley; David Walker, Former Comptroller General of the Federal Government and dozens of other commentators, politicians, and members of think tanks. The most compelling figure in the movie may have been Larry Kotlikoff who makes the case that the national debt, using fiscal gap accounting, is actually much closer to $200 Trillion.  As it turns out, the U.S. is the only country in the world that doesn’t account for off the book promises like Social Security, Medicare and Medicaid when figuring its national debt.  Our true debt to GDP ratio, Kotlikoff explains, is actually much close to 1000%.  So our current 100% debt-to-GDP ratio would be ten times greater if we lived in any other country in the world.  Hardly World War II levels. The next closest country in the world is Japan that has a debt to GDP ratio of “only” 250%.  As the Honorable Tom McClintock explains, we are fast closing in on sovereign debt crisis, when countries stop loaning us money because they don’t think we can pay it back.

Nearly every expert in the movie agrees on this point:  every year that goes by where Congress fails to either dramatically increase revenue or dramatically reduce spending, the fix on the back end becomes all the more draconian and austere.  The movie is full of math calculations and projections that are incontrovertible and make a compelling case for dramatically higher taxes, even as soon as ten years from now.  This should serve as a warning cry for many investors (especially those in the middle tax brackets) who rely exclusively on tax-deferred investment accounts in retirement.

The next argument advocates of this strategy generally pull out is that “since our US debt is out of control and the Fed is printing money like crazy then tax rates are sure to go up in the future.”  Several articles/books I’ve seen suggest tax rates are likely to double.  While I won’t deny that it is quite possible that tax rates will go up in the future, I don’t buy that our national debt is particularly out of control by historical standards.  Take a look.

There is no relationship between printing money and increasing tax rates and I make no such connection in my book.  What’s more, we know that the Medicare program, the single biggest line item in the US budget, cannot be paid for by printing more money.  Why?  Because if the value of the dollar is reduced by half through loose monetary policy, the cost of a doctor’s appointment would increase commensurately. The more you print money, the more expensive the cost of medical services.  Alan Auerbach, the professor from Berkeley makes this argument very persuasively in our film.

This chart from The Atlantic shows that while our debt as a percentage of GDP is high, it certainly isn’t anything particularly different from what we’ve had in the past.  It was a whole lot higher in the 1940s, and we saw plenty of prosperity in the 1950s and 1960s (and if you go back and look at the other graph, the effective tax rate didn’t go up during those decades.)  I suspect that most people making this argument are either uninformed about history, or selling something (like books, ads, or more likely, whole life insurance.)

The high debt to GDP ratio at the end of World War II was followed by massive government cuts in spending known as military demobilization.  They fired 10 million government workers and sent them back into the private sector.  That, more than anything else, is why we experienced relative prosperity in the 50s and 60s. Even a cursory study of history reveals this.  I have not seen any politicians proposing these types of dramatic spending cuts.  Remember, back in the 50s and 60s they didn’t face the prospect of massive entitlement spending or the impending march of 75 million baby boomers out of the workforce and onto the rolls of entitlement programs.  We draw a false equivalency when we compare the fiscal world in which we now live to that of our country in the immediate wake of World War II.

Furthermore, it’s not our current debt that should alarm us.  It’s what it’s calculated to grow to over the next 30 years.  Absent dramatic cuts to entitlement programs, our debt will increase by $2 trillion per year, on average, over the next three decades.  Moreover, the reason we’ve been able to sustain all this debt up until now is because of historically low interest rates.  If interest rates return to historically normal levels, we could see the cost of debt service triple or even quadruple.  That’s just the cost of renting the money we’ve already spent, let alone all the other things that we’ve promised but can’t afford to pay. We are fast approaching a day where the interest on all that debt will crowd out all the other expenses in the budget.

Lack of Understanding of Filling the Low Brackets

There are a lot of people who don’t get this.  It turns out that maximum tax rates can go way up between when you contribute to a 401K and when you withdraw your money and you can still come out ahead.  Not only do you get decades of tax-protected growth, but you are also likely to have far less taxable income in retirement than when you are working.  For example, you might have enough income while working to be in the 6th bracket, but since you need/have far less income in retirement, you might only be in the 2nd or 3rd bracket.  So even if each bracket went up 5% or 10%, you STILL have a lower marginal rate in retirement.

You also may get to withdraw a significant amount of that income at less than your marginal rate.  A typical doctor might save money at 33% by contributing to his 401K, and then withdraw a good chunk of it at 0%, 10%, and 15%, such that his effective rate on withdrawing is 10-20%.  Obviously, saving taxes at 33% and paying them at 15% is a winning strategy.  Who benefits from talking you out of maximizing your 401K contributions?  Those who are selling an “alternative retirement account” i.e. cash value life insurance.  I don’t know if insurance salesmen are ignorant or conniving, but either way you probably don’t want their advice on this question.

Again, The Power of Zero is not targeting those in the 32 to 37% tax brackets which is where most doctors and dentists reside (though I’m not definitively saying they should completely ignore the strategies in the book).  It doesn’t necessarily make sense to forego a tax deduction at the highest marginal tax rates with the expectation that tax rates in retirement will be even higher.  It does, however, make sense for those in the 22% tax bracket to convert up to the top of the 22% tax bracket or even venture into the 24% tax bracket.  Why?  I’m absolutely convinced that when our nation’s fiscal crisis comes to a head in 2030 or so, we will look back at the 22 and 24% tax brackets as good deals of historic proportions.  David Walker, the former Comptroller General of the Federal Government famously said in a CNN op-ed in 2009 that tax rates in our country will likely have to double before all the dust settles.  Even if you account for the two lowest two tax brackets (10 or 12% or their future equivalent) in all your retirement calculations, your retirement plan would not likely survive a doubling of tax rates.

Lack of Understanding of the Cost of Roth Contributions/Conversions

Regular readers know I am a huge fan of tax diversification in retirement.  By having money in tax-deferred accounts, Roth accounts, and taxable accounts, you can minimize your tax bill in retirement, which, all things being equal, is a good thing.  I contribute to Backdoor Roth IRAs each year and when I was in the lowest tax brackets (residency and military service) I preferentially put money into Roth accounts.  I may also do some Roth conversions in low income years and early retirement years.

Roth is great.  However, when you’re in your peak earnings years and you have to choose between tax-deferred and Roth contributions, the right choice for most is the tax-deferred account.  There is a very real cost to going Roth.  For example, if you have a $17,500 401K contribution and you’re in the 33% bracket, going Roth is going to cost you $5,775 in taxes.  If it were a SEP-IRA (which you could then convert to a Roth IRA) with a $52K contribution limit, that would cost you $17,160 in taxes.  That is hardly insignificant.  Yet, that is what these folks are advocating you do.  “Pay your taxes now, while they’re low.” Well, 33% isn’t low compared to the rate at which most people are going to be withdrawing money.  Conversions are the same deal.  They cost money, and if you’re in a high bracket, they cost a lot of money.

Again, very few Americans fall into these higher tax rates. I have never argued that investors at these high levels of income should perforce consider Roth Conversions. Short of massive increases in tax rates (a true doubling of rates, even for those in the highest marginal tax brackets) it’s hard to make the math work.  This is, again, why all of my examples in the book were clearly focused on Americans in the middle tax brackets.

Also, before dismissing all Roth Conversions out of hand, consider the example of those who will be receiving a pension in retirement.  That pension is construed by the IRS as provisional income which will cause up to 85% of their Social Security to become taxable at their highest marginal tax rate.  If that’s the case, these two sources of taxable income could easily consume those first two tax brackets (10% and 12% or their future equivalent) in retirement.  Any distributions that are taken out of IRAs or 401k’s at that point will be piled right on top of all that other income and be taxed at the 22% tax bracket (or its future equivalent).  If that’s the case, and one finds himself in the 22% tax bracket, why let a year go by without maxing it out through Roth Conversions?  By the way, 24% is only 2% worse, but allows you to convert an extra $150,000.  Why not take advantage of that bracket as well? Over half the pre-retirees we meet with have large pensions and fit into this scenario. This is a no brainer recommendation where the math wins every time, especially given the expiration of the Trump tax cuts in 2026.

Mixing Insurance and Investing

Perhaps the biggest reason I dislike this idea of going for a zero percent tax bracket in retirement is it causes people to “invest” in cash value life insurance policies that they wouldn’t otherwise buy.  Remember that I said that all things being equal, a low tax rate in retirement is great.  However, all things aren’t equal if you’re paying taxes at high marginal tax rates in your peak earnings when you don’t have to and they certainly aren’t equal if you’re earning the low returns available in whole life insurance instead of the higher returns available with more traditional investments like stocks, bonds, and real estate.  Remember you buy life insurance with after-tax dollars.  So you can put $17,500 into your 401K, or you can pay a life insurance premium of $11,725.  If the 401K investment grows at 8% and then is withdrawn at a 15% tax rate, and the life insurance cash value grows at 4% and then borrowed tax-free (but not interest free) 30 years later, the difference is $149,682 vs $38,029.  Which would you rather have?  I don’t particularly think that cash value insurance compares favorably with a taxable account, but I can understand why some conservative, highly taxed investors might find it attractive.  However, when you compare life insurance to a 401K or Roth IRA, the insurance nearly always comes out looking terrible.

Getting to the 0% tax bracket doesn’t require using cash value life insurance and my book never makes such a claim. Many of our clients rely solely on all the various forms of Roth IRAs to mitigate the effects of future tax increases.  In the right circumstances, however, there are some compelling reasons to consider cash value life insurance.  The vast majority of my clients utilize cash value life insurance for the long-term care benefits.  Turns out, most people want long-term care insurance but they don’t want to pay huge premiums for something they hope they never have to use. According to The Wall Street Journal, 260,000 cash value life insurance policies were bought in 2017 with the express purpose of paying for long-term care.  Most of our clients fall into this category. Compare that to the 66,000 traditional long-term-care policies sold in the same year.  With internal rates of return (including the death benefit from which the long-term care benefit is drawn) that approach 6%, this is hardly an inefficient way to safely grow a small portion of your portfolio, especially when considering the other risk-free alternatives (savings accounts, treasuries, etc.). To paint all cash value life insurance policies with the same broad brush is to ignore the growing number of well-informed investors who prefer to leave a death benefit to their heirs in the event they die never having needed long-term care.

Furthermore, I don’t think it’s useful to compare life insurance cash values that average 4% to 6% over time to stock market portfolios that average 8%. Most investors consider the cash value in these policies to be part of the bond portion of their overall portfolio and are perfectly satisfied with bond-like returns over time. If they are taking money out of stock market accounts to fund these policies they are, in turn, increasing the percentage of stocks in their portfolio to compensate. Comparing life insurance cash value to stock market returns isn’t apples to apples, it’s fruit salad.

Lastly, there are plenty of cash value life insurance policies that have guaranteed provisions that allow for tax-free and interest free loans. When WCI makes the categorical claim that all policies charge a net interest rate for loans, he reveals an inexperience and unfamiliarity with the various policies available in today’s market place.

Trying to get into the 0% tax bracket in retirement eliminates the benefits of spreading your income out over many years (and thus fully utilizing the low, non-zero brackets).  It can also cause you to make mistakes in the Roth vs Tax-deferred decision and in the Investments vs Insurance (masquerading as an investment) decision.  The goal isn’t to pay as little in taxes as possible in retirement.  The goal is to have as much after-tax, after-expense money to spend as possible in retirement, at least when adjusted for risk taken.  Don’t fall for the Zero Percent Bracket argument made by insurance agents when selling their wares.  Tax diversification is good, but only at the right price.  Going for the Zero Percent Bracket will probably cause you to pay too high a price.

Again, if you don’t allow for the possibility that tax rates in the future could be higher than they are today, even dramatically so, (which we may never actually agree upon…unless WCI deigns to watch my movie), you can’t safely say that the cost of getting to the zero percent tax bracket is too high, especially for those in the middle tax brackets.  If you can guarantee (in the face of all the expert testimony in our movie and elsewhere) that taxes will stay roughly level for the rest of our lives, then you may be able to make the case that the cost could be too prohibitive, but in only about half of the circumstances (excluding those who have pensions).

In conclusion, I am confident that time will vindicate the strategies in my book.  I am likewise confident that WCI investor will look back at his post 10 years from now and be ashamed that he impugned the integrity of an honest man by calling reasonable, math-based strategies a “scam”. As the fiscal condition of our country grows more dire with each passing year, more and more Americans will agree with my assessment.

What do you think?  Do you plan to pay zero taxes in retirement?  Why or why not?  Have you heard this argument from insurance agents?  Sound off below!

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