0:00:05
A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
0:00:20
Hello there. This is David McKnight, author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. Grateful that you're part of the show today, this is The Power of Zero show, appreciate you taking some time out of your busy schedule to learn about The Power of Zero paradigm. You can find me at davidmcknight.com or powerofzero.com.
0:00:44
Today, we are going to talk about a couple of pieces of legislation that are working their way through both the House and the Senate. Both acts, both pieces of legislation are striving to close some loopholes and various retirement laws and shore up some things that will encourage Americans to save earlier, save more often, so that by the time they reach retirement, they are not relying on Social Security alone. Social Security alone is not enough to maintain a standard of living, and I think Congress has long realized this so they're trying to put incentives into the tax code to encourage people to save more often and save earlier.
0:01:33
Now, I think that the intent of both of these acts of legislation are in some parts noble. First of all, let's address what's going through the house right now, it's a doozy of an acronym, Setting Every Community Up for Retirement Enhancement Act, the acronym there is SECURE. Sometimes they pick a word and say, “Let's build this an acronym backwards, let's back into it,” they like the word secure and they found a bunch of words that aligned with that acronym so we've got the Setting Every Community Up for Retirement Enhancement Act, that is the legislation working its way through the House. Of course, the Senate is working on their own piece of legislation, so the RESA, that's Retirement Enhancement and Savings Act. A lot of the stipulations in either piece of legislation have a lot of things in common. They both want to have retirement plans that have annuity options within them. They want to require retirement plans to at least once a year tell the contributor to the retirement plan what their lump sum would equate into in terms of an annuity payment that would start at retirement and go every year until they died. I've long believed in Tom Hegna, for those of you who have heard Tom Hegna speak, read his book Paychecks and Playchecks, he is a big proponent of this idea that it's about income, not assets, and I'm also a big believer of that. Could you imagine that if you opened up your your Roth 401(k) statement and you saw on there a note at the top of the page that said, “You will have $3,500 per month coming out of this account starting at age 65 and going every year until you die”? Could you imagine if that was required to be put on your investment statement at least once a year? How great would that be if you had $3,500 per month coming out of your Roth 401(k) that's not provisional income, that's truly tax-free, that's not causing your Social Security to be taxed, it's insulated from the impact of higher taxes, and it's guaranteed to flow to you every year until you die? I love streams of income so long as they are not coming out of your tax-deferred bucket, and if they are coming out of your tax-deferred bucket, in very, very concentrated doses enough to keep you below your standard deduction but also enough to not cause your Social Security to be taxed. I think that's a very, very positive development.
0:04:20
There's talk in the house measure of pushing the required minimum distribution from 70 1/2 all the way up to 75. In the Senate, their stipulation says that they want to push RMDs back until 72. For people who don't have a lot of money in their IRAs and they're relying heavily on their IRAs, this is not going to be a big deal because they're going to need to tap into that money probably much sooner than 72 or 75 anyway, so that required minimum distribution is not a big deal. Who is this going to affect? This is going to affect people that are not necessarily dependent upon their RMDs right away. It's going to let them continue to grow and compound, those IRAs, and push those required minimum distributions further out. I think that's probably going to create even bigger problems because their RMDs are going to be even bigger and it's going to force them to rise into an even higher tax bracket. We don't have any word on what the required minimum distributions amounts are going to be, is it still going to be that first year you are required to take out 3.65%? Remember what required minimum distributions are designed to do, they're designed to force you to liquidate these IRA vehicles before you die. My thought would be that if they're pushing the RMD minimum age limit back to 72 or possibly 75, that they could potentially require you to take even more than 3.65% out, we'll have to see. But it seems to me, if the goal and intent of an RMD is to have you draw down an asset before you die and they're giving you less time within which to do so—so instead of taking the money at 70 1/2, you're taking it at say 75—that means you have less time until you die before you're going to liquidate entirely that asset. There's a thought that potentially, the 3.65% minimum amount could go up which, of course, if you're pushing those RMDs back, your money has grown and compounded even more so you have a larger lump sum that you're drawing from and then potentially the amount that you're required to take out is even higher, and then tax rates, of course, as we all know are likely to be dramatically higher in the future than they are today. This could spell big trainwreck for people who feel like they don't need to take money out of their IRAs because they're going to have a larger amount of money in there, be forced to take a larger stream of income out, and do so at a period in time when tax rates are likely to be dramatically higher than they are today. That's a really interesting component of it.
0:07:18
Another interesting component of it which I think could potentially have catastrophic implications is that if you consider what a stretch inherited IRA provision currently allows for. If you inherit an IRA from your parent, you currently are allowed to take RMDs out of that IRA over your own life expectancy. It's designed to allow you to take minimal amounts of money out of that IRA, sure it'll be lumped right on top of all your other income and be taxed at your highest marginal tax bracket, but currently, they're not requiring you to take a lot of money. If you're 35 or 40, when you start receiving these RMDs, it's enough to liquidate the asset over your life expectancy. If you live for another 50 years, the amount that they're going to force you to take out is not all that great, not a lot of huge implications currently given these stretch provisions.
0:08:29
However, what's being floated in these two pieces of legislation, instead of allowing you to take this over your life expectancy, they could force you to spend these assets down these IRAs over a 10-year period, in other words, they'll use some sort of calculation that says, “What amount of distributions would likely liquidate this IRA over a 10-year period?” and that is the amount that they force you to take. Imagine, if you will, inheriting a $1 million IRA and being forced to take, let's call $125,000 per year for 10 years, you will be forced to pay taxes on that, that's going to flow into your graduated cylinder right on top of all your other income probably at a period in time when tax rates are dramatically higher than they are today at the apex of your earning years. Let's assume you're in the, let's call it the 32% tax bracket, you're forced to take $125,000 as ordinary income in the year in which you receive that inheritance and that pushes you up into the 35% tax bracket, thrown another 7% for state, now all of a sudden, you are paying 42% tax. Every year, assuming tax rates stay where they are today, by the way, that'll be higher if that happens after 2026, and if we're moving forward in time to 2028, 2030 and beyond, you're almost certainly going to be paying much higher taxes. This is a huge tax grab by the IRS. There are lots of nice little provisions in this Act. For example, you currently cannot contribute to an IRA beyond the age 70 1/2, you can incidentally contribute to a Roth IRA beyond 70 1/2, but not a traditional IRA, they are looking to eliminate that little provision. They are looking to give tax credits to small businesses that make it easier for their employees to make contributions and get automatically enrolled into their company plan. They're doing these nice little things to try to make sure that people have more money that they're saving for retirement, but then what are they doing on the back end? On the back end, they're saying, “Now that you've accumulated all this money, if you don't allow us to tax you on it during your lifetime, when you die, we are going to have a huge tax grab here.” They're encouraging you to save more money, but then if you die not having spent it, not having allowed them to tax you on it, they are going to have this 10-year period where you’re forced to spend down all these assets as an heir and you're forced to pay taxes on them at your highest marginal tax bracket which, like I said, is likely to be much higher than it is today at the apex of your earning year right on top of all your other income.
0:11:36
I'm lauding a lot of the provisions in these two bills that encourage people to save, they give benefits and incentives to companies that make it easy for retirees to save that push back required minimum distributions. That one is not going to really benefit Main Street America, it's going to benefit people that have so much money that they don't need it to take the RMDs, although I think that even so, we need to keep a close eye on what percentage they're going to be requiring us to take, if it’s still 3.65%, you're not spending down as much, but the minute you die and pass that on to the next generation, then all of a sudden, the real tax grab begins and your money gets liquidated over 10 years.
0:12:35
There's a couple of things that I think are laudatory here, that are praiseworthy that I think are worthy of note, but there's a couple of things here that really give me pause, especially from a tax planning standpoint, especially from a Power of Zero worldview. If this legislation is put into place and there's reason to believe that some version of this is going to be signed into law by President Trump, because it's not very often that you have bills in both houses of Congress that have this much bipartisan support, it's likely to be signed into law in some version that's not vastly different than what we're seeing right here, they just have to find a middle ground over whether it's age 72 or age 75 for the RMD. How do you prepare for this potential tax apocalypse, this potential complication to everything that we've talked about in all of our podcasts up to this point? All this really does is underscore the need to do more tax planning, in other words, all the more reason to systematically shift money out of tax-deferred accounts, like 401(k)s and IRAs, into tax-free by way of Roth conversions, by way of making shifts into life insurance retirement plans so that you can insulate and protect yourself from the reality that if you die with money in that bucket, your heirs will be forced to spend that money down.
0:14:15
Now keep in mind, if the money goes to a spouse, you're not going to be forced to spend that money down in 10 years, however, as a widow or widower, as a single person, your tax bracket just got chopped in half, so now you rise twice as quickly in the tax cylinder so it's much easier to hit those higher levels, that's not awesome. If there's any money left over at the end of that spouse’s life, then of course, we have this 10-year period where whatever happens to be left over is going to be forced to be spent down. All the more reason to proactively and preemptively pay taxes on these accounts at historically low tax rates so that by the time you are ready to pass on, by the time your life is over and you want to stretch the efficiency and wring every last bit of efficiency out of these retirement dollars for the benefit of your heirs, you've already paid the price, you've paid the tax, you've done so at historically low tax rates. Now your heirs can take advantage of these funds that you've so diligently saved your whole life, do so in a tax-free way, not be required to spend those dollars down, and probably be able to take advantage of a nice little financial shot in the arm at a period in time when they're probably paying lots of taxes and could benefit from this additional tax-free income in their life.
0:15:44
I will certainly keep you apprised on the developments as it relates to these two pieces of legislation. Once the final legislation starts to crystallize and we understand what the final bill is going to look like, and certainly when it passes, we will keep you apprised of all this. But all of this has vast implications for people who are saving for retirement.
0:16:04
Thanks for being on the podcast today. Of course, if you need help with your own personal plan, go to davidmcknight.com. If you would like to buy books in bulk, you can go to either davidmcknight.com or powerofzero.com. Thanks for being on the show today and we will look forward to chatting with you next week. Talk to you soon.
