Episode 29: Five Key Takeaways of The Power of Zero Message with David McKnight

Hello there. David McKnight. Welcome to The Power of Zero show. Grateful that you took a little time out of your day to join me. I am the author of the best-selling book The Power of Zero, Look Before You LIRP, as well as my most recent release, came out a few weeks ago called The Volatility Shield. You can check that out on Amazon, and you can get any of those books in bulk if you go to powerofzero.com or davidmcknight.com, either one will lead you to bulk discounts.

The first takeaway is that tax rates in the future are likely to be dramatically higher than they are today. I tell groups all across the country, I wish there were a better way around this, I wish there was a way to solve that math problem—that David Walker talks about—other than by raising revenue substantially over the next 10 years but I just can't see a way around it. Politicians are so averse to cutting spending, they're so averse to cutting Social Security, Medicare, and Medicaid that the lion's share of 78 million baby boomers are going to be relying on in a very big way over the course of the next 20 years. To cut those programs would effectively vote those people out of office, it's the proverbial third rail of politics, you think of the Metro, you think of that third rail, it says, “Danger. Do not touch, high-voltage,” the third rail of politics is Social Security, Medicare, and Medicaid, you touch those programs, you get zapped right out of office. I often talk about how in my former home state of Wisconsin—I now live in Puerto Rico—but my former home state of Wisconsin, Paul Ryan was often seen on TV during primaries, pushing old ladies off a cliff in a wheelchair, of course, this was what happens to politicians anytime they even broach the subject of reforming Social Security, Medicare, and Medicaid. Remember, we're at $22 trillion of debt, and the reason why that debt is growing and will continue to grow is simply because of those unfunded obligations in Social Security, Medicare, and Medicaid. We've promised way more than we can afford to keep and the only way, really at this point, to bridge that shortfall is to either double taxes, reduce spending by half, or some combination of the two.

Takeaway number two, the only way to truly insulate yourself from the impact of higher taxes is to get to the 0% tax bracket. Why? Because if you're on the 0% tax bracket and the tax rates double two times, zero is still zero. That really is The Power of Zero. When you're in a 0% tax bracket, you've effectively insulated yourself from the impact of higher taxes. Now, all the time, about half the people we see can never get to the 0% tax bracket, what we tell them is, “Hey, if you have a pension, that pension will cause your Social Security to be taxed, you will never ever get to the 0% tax bracket. But hey, let's worry about the things that we can control, let's not worry about the things that we can't control. Let's divide our world into two halves, the things that we can control, the things that we can't control. Whatever money's in your IRA and 401(k)s, those are things that you can control, why not systematically shift those dollars into the tax-free bucket, do so at the lowest tax brackets you're likely to experience in your lifetime, and then once tax rates go up for good, you've done all the heavy lifting, now you can take those dollars out tax-free? Even though you won't be in the 0% tax bracket when it comes to your pension and your Social Security, all of those other dollars will be tax-free and you will have effectively insulated yourself from the impact of rising taxes.” That's takeaway number two.

I love the Roth IRA, just the traditional plain-old-vanilla Roth IRA because you have instant liquidity. If you are in a bind, then you need to tap into those dollars, you can tap into them instantly, at least, whatever you've put into it, you can get back out, obviously, you gotta have the 5-year waiting period until you're either 5 years from now or 59 1/2, whichever is longer. That's obviously a great advantage is having the liquidity on that Roth IRA that a lot of these other tax-free vehicles don't offer you.

I love leaving a little bit of money in your IRA in retirement. Why? Because if you can leave—and this is assuming you don't have a pension or any other sources of residual income in retirement other than Social Security—if as a married couple, you can leave about $350,000 or so, if as a single person, maybe about $175,000, what you'll find is that your RMDs on that IRA amount get offset by your standard deduction, but there also keep those RMDs low enough that as provisional income, it doesn't cause your Social Security to be taxed. This is probably my favorite of all the streams of tax-free income simply because it's what I call the holy grail of financial planning, you get a deduction on the front end when you put money into that IRA or 401(k), it grew tax-deferred, and then when you take the money out, you take it out tax-free. That's a pretty good deal and there's not a lot else out there that can do that allows you to spend the money on whatever you want; certainly, you have HSAs, but you're constrained in terms of what you can spend that money on.

I love the LIRP because the LIRP can give you safe and productive growth, it's tax-free, but it can also give you a death benefit that doubles as long-term care. I think that one of the major reasons people—at least, in my mind—that I see day in and day out love the LIRP is it gives them a way to sort of solve the long-term care conundrum by using a death benefit in advance of your death for the purpose of paying for long-term care. What do people have against traditional long-term care insurance? They have this whole abhorrence of a use-it-or-lose-it proposition. At least, with the LIRP, if you die peacefully in your sleep 30 years from now, never having used it, someone's still getting a death benefit at the end, it's a great way to pass money tax-free to heirs. Those are six different streams of tax-free income that work collaboratively together. I'd like to say it's like a piece of a puzzle, when you can get these different pieces of the puzzle to work perfectly together, then the 0% tax bracket comes into focus. But remember, it's not easy, you can't do it in a willy-nilly or haphazard way because if you don't respect all of these different thresholds—Social Security thresholds, RMD thresholds—you're not going to get to the 0% tax bracket. One change on one side might affect a massive change on the other side. You've got to use these in very moderated ways.

Fourth takeaway, as of January 1, 2018, tax rates went on sale. Every year that goes by where you fail to take advantage of historically low tax rates is potentially a year beyond 2026 where you could be paying the highest tax rates you've seen in your lifetime. I remember, people used to ask me, “Dave, when are tax rates going to go up?” and I think rather justifiably so I would say, “Some points, maybe 10 years out, tax rates are likely to edge higher, go higher, what have you,” guess what, given the Trump tax cuts and given the sunset provision in those tax cuts, we now know the year and the day when tax rates are going to go up. Remember, the one thing that prevents people from making important decisions, like Roth conversions and things like that, is they are afraid that they may pay a tax today at a higher rate and not be able to pay that rate down the road when tax rates are lower. Guess what, we now have a whole lot more certainty surrounding the tax code. We now know that in 2026, tax rates will revert to exactly what they were prior to 2018. The highest marginal tax bracket will go up to 39.6%, the 12% will go to 15%, 22% to 25%, 25% to 28%, so on and so forth. All Congress has to do nothing, Congress is pretty good at doing nothing in order to get a tax raise. It's going to happen, don't listen to the media, the media tells you that this tax cut only benefits the top 1%, I'm telling you, everyone benefits from this tax cut.

Takeaway number five. I have people often come up to me after my workshop and they'll say, “Dave, what am I to do? You have basically scared me to death and made me feel like I've done all this wrong, that I've done it exactly the wrong way,” and I'll say, “Why is that?” They'll say, “Because I've got all of my money wrapped up in my tax-deferred account and you've scared me to death,” to which I respond, “You know what? Whether you did it wrong or not is actually up to you because I will tell you right now that if you treat the next seven years perfectly, you have a chance to make sure that you did it exactly right,” and here's why, chances are, when you put money into those IRAs or 401(k)s, you did it at a period in time when tax rates are likely to be or likely were higher than they are today. You now have a chance for the next seven years to get those dollars shifted into a tax-free bucket and the cost of doing so is historically low, you'll never see taxes as low as you see them over the course of the next seven years. Of course, once 2026 rolls around, tax rates will go back up to what they were in 2017. I believe wholeheartedly that in 2028, 2030, and beyond, tax rates will go even higher, so guess what, so long as you take advantage of the next seven years, you have the opportunity to make sure that this whole thing plays out exactly perfectly. Why? Because you want to get deductions when tax rates are historically high, you want to pay the tax when tax rates are historically low, and then when tax rates go back up again, you want to take money out of tax-free vehicles. If you can do that, then you can actually play this out perfectly and really ring every last bit of tax efficiency out of your retirement dollars.