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A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
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Hello there. David McKnight. Welcome to The Power of Zero show. Thank you for taking just a few moments out of your day to spend some time with me. I'm the best-selling author of The Power of Zero, Look Before You LIRP, and now, The Volatility Shield, all of which are available at my website powerofzero.com or at davidmcknight.com. If you want the bulk discounts, go to powerofzero.com, it will lead you right to the link bringing you to bulk discounts. As a reminder, if you want to get this podcast sent to your email inbox on any of your favorite channels—YouTube, Spotify, Pandora, iTunes, what-have-you—please, simply subscribe and it will come to you every week on Wednesday.
0:01:09
Today we're going to talk about this question that I get posed quite a bit actually and it's this: Can I have too much money to get to the 0% tax bracket? In other words, can I have so much money that it doesn't make sense to get to the 0% tax bracket? My answer is probably no. Here's why, more often than not, it's the people that have $3 million or more that ask me this question. The thing that I think that they are afraid of is in the process of getting to the 0% tax bracket, will they pay so much tax that it doesn't make sense to go through all of the work, the heavy lifting, the high tax rates in order to get to the 0% tax bracket. Where it really comes down to is it comes down to, during the course of the next seven years, when you can avail yourself of the 37% tax bracket, do you feel like that is a good deal? Do you feel like that is a tax rate where 7 years or 10 years from now when tax rates rise dramatically, you'll look back and say, “Man, I'm glad I paid those taxes. That was a good deal of historic proportion,” or will you look back and say, “Man, why did I pay the taxes preemptively when I could have just waited and maybe paid a lower tax rate?” A lot of my answer to all of this revolves around Required Minimum Distributions.
0:02:46
Now I want you to think for a minute that the IRS has designed RMDs or Required Minimum Distributions to force you to pay taxes on all of the dollars that you have in your tax-deferred account before you die. The goal is for them to get their tax dollars during your lifetime before they die so that you don't squirrel it all away and they're not able to have a predictable and repeatable stream of income so that they can pay their taxables. Remember, in the cumulative 401(k)s and IRAs across the country, there's about $22 trillion. The IRS wants to be able to have some sort of predictability, they want to be able to know when they can start drawing down tax dollars on those accounts. Starting at age 70 1/2 or April 15th following 70 1/2, they will force you to take 3.65%. That number goes up every year; the next year at 71, it goes up to 3.78%, then 3.91%, then 4.05%, all the way up until by the time you're 85, it's 6.76%. You can start to see how if you're not taking a lot of risk in those types of accounts, you're not getting huge rates of return, you can really start to spend down those assets or be forced to spend down those assets during your lifetime.
0:04:18
For today's example, we're going to use the number $5 million. If you have $5 million that first year, you're going to be taking out about $175,000, that's how much they're going to force you to take out, 3.65% of $5 million is going to get you the $175,000 area. The next year, you're looking at taking a little bit more, a little bit more, a little more. Before you know it, you are bumping up into the equivalent of the after 2026, we're talking about getting past the 28% tax bracket into the 33% tax bracket, the 35% tax bracket, and before you know it, if you have $5 million, you could very easily be—depending on the age in which you're forced to draw these assets down—you could be in the highest marginal tax bracket. It's certainly higher than what you could be today if you preemptively started to shift these dollars to tax-free even if you’re paying 37%. The whole point of The Power of Zero worldview is that we think even 10 years from now that tax rates are going to be dramatically higher than they are today. If tax rates rise dramatically, the equivalent of the 37% tax bracket could be 50%, in which case, you'll look back on the years 2019 through 2025 and say, “Thirty-seven percent really was a good deal, why did I not take advantage of it?” You have to look at all of this in context. You have to consider what tax rates are going to be now versus where they could potentially be somewhere down the road.
0:06:02
Now, there's one other thing I want to bring to your attention, and that's this, couples don't always die at exactly the same time. If a spouse outlives the other spouse by five years, there's going to be a five-year period where that spouse's tax bracket could potentially be chopped in half, which means that tax brackets, not as much on the top end but certainly on the lower to mid-portion of the tax brackets, your tax bracket basically gets chopped in half. You could be spending a lot more money on those RMDs than you ever thought possible because taxes basically double. It may not affect you as much on the margin because they start to equalize the higher you get, but certainly, in some of those lower tax brackets, your effective tax rate can rise dramatically. That's part of it. I'm not going to make as much of a deal a big deal about that as I am the next thing.
0:07:04
The next thing is I want to talk about—I'm going to do a whole different podcast on what I'm going to talk about next—and that is the legislation that's currently in the House, there's similar legislation in the Senate, but my understanding is they're very, very similar, there's only a couple of different things, for example, in the House, they want to push RMDs back to 72, in the Senate, they want to push RMDs back to 75. But here's the clincher, while that seems like a great thing on the surface, here's what you have to consider, they also want to eliminate the ability for your children to stretch your IRA out over their lifetimes. Currently, if you are a beneficiary of an inherited IRA, you're not a spouse, but you're a non-spouse beneficiary, you have the ability to stretch those RMDs out over your lifetime, which is great because you don't have to take that much money out, you may not necessarily feel like you need the money, and they're not forcing you to take a lot out. What little bit they are forcing you to take out gets taxed at your highest marginal tax bracket, which may not be a big deal, especially if it's $10,000 a year or $20,000 a year, it may not bump you up into a high prohibitive tax bracket. However, if they get what they want and it seems like both sides are of one accord on this issue, and that is that they want to eliminate those stretch IRA options and they're going to force you to pay tax on those dollars over a 10-year period, in other words, you're going to amortize those dollars out over 10 years, force you to spend that—if it's $5 million that you have in your IRA—force you to spend that $5 million IRA down to zero over the course of 10 years. What's that going to do to your beneficiaries? Your beneficiaries, even if they're in a low tax bracket today, could you imagine if they were forced to receive $300,000 or $500,000 per year over 10 years or more, and forced to pay taxes on those assets on top of what they're already paying? They will likely pay tax at the highest marginal tax bracket, which will—if you're planning on dying after 2025—is going to be at least 39.6%, in which case, you have made the good move by shifting those assets from tax-deferred to tax-free and paying only 37%.
0:09:36
In the big scheme of things, I think that's a really big deal. Most experts seem to believe that this is coming down. This tells you that the US government is really hurting for tax revenue, they're willing to, instead of taking revenue off of your IRA assets over your heir’s lifetime, they're going to force them to pay taxes on it over 10 years. If you have $5 million in your IRA and you're thinking, “Ah, I'll be good. My kids will just inherit this money, they'll spend it down over their lifetime,” that may not necessarily be the case. If they're forced to spend it down over 10 years, they are going to have to realize a lot of taxable income each and every year. It'll probably be on a period in their lives when they're at the apex of their earning years so it's going to be at a high marginal tax bracket, it's going to be a period in their lives when tax rates are likely to be dramatically higher than they are today, in which case, it's going to be a total disaster. You've scrimped and saved all this money all your life, you maybe didn't want to spend it all in retirement, and you thought, “Hey, I'm going to send this to the next generation,” they're not going to be able to keep that much of it, in fact, there's a good chance that they'll only be able to keep about half of it. Ask yourself, if you have large amounts of money in your IRA, “Does it make sense to pay taxes today versus postponing the payment of those taxes still somewhere down the road being forced to take RMDs or having your spouse be forced to pay taxes, have a compromised-tax bracket, or does it make sense to force your kids to pay taxes on it over the course of a 10-year period?”
0:11:25
For that reason, I think that it makes sense—I'm not saying every single case—but I think it makes sense to strongly consider preemptively paying some tax on those dollars if you have lots of money in your IRA and you think that this is not necessarily a good fit for you, I think it makes sense to look at what the alternatives are. If you're not going to shift that money to tax-free today, what's it going to look like either for your spouse when you die or what's it going to look like for your heirs? I don't think either of those scenarios is all that great.
0:11:56
Now if you have a ton of money sitting in your taxable bucket, that may be a different story. I happen to believe that if you can get money in your taxable bucket shifted over to tax-free, then it's going to grow more productively, whether it's by way of a Roth IRA, or particularly—chances are if you have that much money, you can't do a Roth IRA—but particularly, if you are looking to shift some of that taxable money into life insurance, I think that mathematically, your money can grow more efficiently. But even if we discard the whole discussion on life insurance, I think there's another consideration, and that's if you have a lot of money in your taxable bucket, you're going to receive a stepped-up basis when it gets passed on to your heirs. Those taxable dollars are going to be treated differently than your tax-deferred dollars. While I do think that those taxable-bucket dollars could grow more efficiently if you shifted it to tax-free, especially if you amortize the difference between taxable and tax-free over a 30-year retirement or what have you, I'm not as worried about it from an inheritance perspective because you would get that stepped-up basis. Will they ever try to remove or take away that stepped-up basis? Probably. As I've always said, as we slip further and further into insolvency as a country, we are starting to look at a situation where the government is putting all options on the table in terms of garnering more revenue.
0:13:28
This is just a little bit of food for thought. If you find yourself in a position where you say, “Hey, I've got too much money to get to the 0% tax bracket,” I think there's a number of considerations you should think about, I think that's not always the case. If you have a lot of money, the IRS is going to get their money one way or the other, so you have to consider if you're not going to pay the tax, who is going to pay the tax? Could it be your spouse at a, what I call compromised-tax bracket, or could it be your children being forced to pay it down over 10 years?
0:14:00
That is the show for today. Again, subscribe to the podcast. If you are looking for a Power of Zero advisor, certainly go to davidmcknight.com or talk to the person that gave you The Power of Zero book. You can certainly ask them some pointed questions about The Power of Zero paradigm. If they answer those questions to your satisfaction, they're probably a good person to talk about this, otherwise, you can always contact us by way of davidmcknight.com.
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For those of you who have not read The Volatility Shield yet, it's really starting to spread the message of that book. Remember it's a fictional novella, it's only 100 pages long, but it tells the story of someone who is trying to figure out how they're going to stretch their retirement dollars as much as they possibly can, but when constrained by the 4% rule, they start to lose hope. There's a crime involved, there's a lot of suspense. There is a cool M. Night Shyamalan twist ending at the end, so if you have not had a chance to read The Volatility Shield, take a look at the reviews on Amazon, the reviews are coming back just really, really well. Just buy a single copy on Amazon, if you want to buy bulk, go to powerofzero.com.
0:15:25
Again, thank you for sharing some of your day with me and we will look forward to chatting with you next week. Thanks for being part of The Power of Zero show.
