A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
Hello and welcome to The Power of Zero show. This is your host, David McKnight. I'm the best-selling author of The Power of Zero, sold over 185,000 copies, as well as Look Before You LIRP, and my most recent release came out a few months ago called The Volatility Shield. You can get all of those books in bulk at powerofzero.com
Today, I am going to share with you an interview that I had with Living a Richer Life by Design, that's a national podcast, it's a two-parter, so you're going to hear the first part today just to give you a sneak preview where I'm going to be talking about the motivation behind my writing The Power of Zero, and subsequently filming the movie, The Power of Zero: The Tax Train Is Coming. We're going to talk a lot about the fiscal challenges facing our country, why we call it a Gathering Storm or a tax freight train bearing down on us, talk about why we believe it's a tax freight train. We've talked about how quickly we think those higher taxes are going to come, we’ve talked about why the 0% tax bracket is so important in the face of higher tax rates, and we're also going to talk about why we feel like the government has been so reluctant to exercise more fiscal responsibility. Finally, we're going to talk about the timeframe during which you can take advantage of historically low tax rates, what does it mean to stretch that tax liability out over seven years, between now and 2026? How do we get all the heavy lifting done before tax rates go up for good? How do we do so in a way that doesn't give us heartburn? We'll touch on the three buckets and we'll talk about how much money people should have in each bucket and how to shift any surplus to tax-free. I hope you enjoy the interview. Thank you.
Mark: Welcome to Living a Richer Life by Design with host Jonathan Krueger, and I'm you're contributing host, Mark Ralfs. Join us as we dive into a variety of subjects including fulfilling relationships, vibrant health, community engagement, social impact, and of course, the stewardship of your finances.
Jonathan: Welcome to Living a Richer Life by Design. This is Jonathan Krueger and co-host Mark Ralfs. On today's show, we'll be talking to David McKnight. David graduated from Brigham Young University with honors in 1997. He has made frequent appearances in Forbes, USA Today, The New York Times, Fox Business, CBS Radio, Bloomberg Radio, Huffington Post, Reuters, CNBC, Yahoo Finance, Nasdaq.com, Investor's Business Daily, and MarketWatch. His best-selling book, The Power of Zero has sold over 150,000 copies, and the updated and revised version was published by Penguin Random House when it was launched in September of 2018. It finished the week as the number two most-sold business book in the world. This book was recently made into a full-length documentary film entitled The Power of Zero: The Tax Train Is Coming. He and his wife, Felice, have seven children.
David, thank you for joining us on the show. We are glad that you're here and look forward to this podcast.
David: It's absolutely my pleasure. Thank you for having me.
Jonathan: Yes, Sir. Before we get started, David, could you tell us a little bit more about yourself, your family, and your background?
David: Yeah, I've been in the financial services industry since 1997, so it's over 22 years. I've been serving people and trying to help them really insulate themselves from what I think is a coming tax storm that will probably come in the next 10 years or so, particularly, over the last 5 years, I've taken it upon myself as a bit of a mission, I've been sort of crisscrossing in the country, trying to raise a warning cry to as many people as possible. My wife is my life partner, she's a mother of our seven children, most of the applause, I think, should be directed in her direction, not mine. We've got a great partnership and a great family. We live in Puerto Rico where it's currently about 90 degrees, so we're enjoying that part of it for sure. I’ve written a couple of books, and really, The Power of Zero is the one that has really captured the essence of my financial worldview and that seems to be the one that has done the best and has really gotten the word out about what we're trying to communicate to the American people. That's about it.
Mark: That's a great background, David, and we appreciate that, and yes, kudos to your wife. Many of us have married up and we know that so congratulations on furthering all those children too.
Mark: Let's get down to it, tell us what your primary motivation was for writing both the book and then subsequently having the film documentary produced.
David: It's interesting, there's a guy named David Walker, he's a former Comptroller General of the federal government, he's one of my personal heroes, if people knew more about him, he would be more broadly recognized as an American hero. He was the Comptroller General of the federal government which basically means he was the CPA of the USA for about 10 years first under President Clinton, then under President Bush, he's actually served under four different presidents. In 2010, he actually created a movie called I.O.U.S.A. A lot of people have seen it, it didn't do extremely well in the box office when it came out but it actually was nominated for an Oscar, it almost won the Oscar, if not for a little movie called Man on Wire for documentaries. In that movie, he talked about how we are marching into a future where we are likely to go bankrupt as a country unless we can radically and dramatically change and redefine our nation's, what he calls unfunded obligations, basically, Social Security, Medicare, and Medicaid. Back then, he was prowling across the country, hair-on-fire, trying to get the word out, and guess what, back then, the national debt was only $10 trillion. It seemed to me, David Walker is one of the people who really warmed me to the idea that politicians are making promises that they simply can't afford to deliver.
There's another personal hero of mine, a guy named Larry Kotlikoff, he's a professor out of Boston University. He pioneered a concept called fiscal gap accounting which basically says that our real debt is not what the publicly-stated debt is, which is $22 trillion, our real debt is the difference between what we have promised and what we can afford to keep, and he does a present value calculation of what we would have to have sitting in a bank account today earning Treasury rates to be able to deliver on all those promises and he says that number is $239 trillion. There's all of this math and corroborating evidence that demonstrates that we are on a very, very shaky fiscal path moving forward, we've made promises that we can't deliver, yet here we are 10 years later after David Walker had filmed his movie and nobody's talking about this stuff anymore it seems like except for me and a handful of financial advisors who believe the math. Part of my reason for writing The Power of Zero is I noticed that not a lot of people are aware that tax rates in the future are likely to be dramatically higher than they are today, or if they are aware of it, they haven't tweaked their retirement plan approach to coincide with what they believe. Currently, there's $22 trillion in the cumulative IRAs and 401(k)s of Americans, there's only about $800 billion in the cumulative Roth IRAs and Roth 401(k)s, and Roth conversions of Americans. Even if Americans believed that tax rates are going up, they haven't done much about it, they haven't changed their approach to retirement yet, so I took it upon myself with the book and then ultimately with the movie to try to get the word out on, “Hey, if tax rates really are going to be higher in the future and dramatically so, we should probably start changing the way that we approach retirement plan.
Jonathan: David, you've traveled around the world, or at least the country, for the last five years now delivering your message, how has it been received?
David: I do about 70 to 80 of these presentations per year, I could do more, I suppose, but I want to have a life and I do have seven kids and I have a wife as we mentioned previously, so I could probably do a little bit more but I obviously want to strike a balance in my life. But I'll tell you, in each of those presentations that I do, people seem to recognize that we are in tough fiscal straits that the federal government has a knack for making promises that it can't afford to deliver on. All you got to do is look at the field of presidential candidates and they're making these outrageous promises like universal health care, we're going to forgive all student debt, and college is going to be free, these are all things that are just absolute pipe dreams. If Americans truly understood the fiscal straits that we're in right now, they would obviously reject all of these proposals out of hand. I think that once people truly get educated, they recognize that math doesn't lie and they also recognize that the math and the numbers don't lie. If they want to be prepared for retirements and the impact of higher taxes, they have to dramatically change the way they're approaching retirement.
Mark: David, in the book in the first chapter, you talk about a Gathering Storm and I think we can discern from what you have said so far what that storm is all about. It appears our country is right in the midst of it now. I'm going to ask for just an opinion here, it seems our politicians show great reluctance to control spending, the answer always seems to be to print more money or to borrow more through the sale of our Treasuries. Why do you believe that the government has been so reluctant to exercise more fiscal responsibility?
David: Because their number one job is to get elected or get re-elected. President Trump, famously, during his election campaign prior to his 2016 election, he said, “Look, I can guarantee this, as president of the United States, I will not touch Medicare, I will not touch Medicaid, I will not touch Social Security.” Why? Because the biggest voting block in the United States, the one that elects every single politician each and every year, baby boomers, one sure way to either not get elected or get voted out of office is to modify those existing programs. If your number one job as a politician is to get elected and you recognize that talking about cutting spending is going to get you voted out of office, then that's what we call the third rail of politics. If you go to the subway in any major city, you see the two rails that the subway runs on, then there's the third rail, it says, “High voltage. Do not touch,” they call Medicare, Medicaid, Social Security politics because if you try to touch it, you get zapped right out of office. It's just not convenient, it's easier to not touch it, it's easier if you're a congressman that has a two-year reelection window, it's easier to just say, “Hey, we're okay for the next two years, why touch something that's not going to go bankrupt in the next two years? My job is to get reelected.” Unfortunately, maybe if we had some term limits that people make some more courageous stands, but unfortunately, as long as the politician's number one job is to get reelected, they're not going to be very courageous in trying to tackle these really thorny issues when it comes to writing the financial ship of state.
Jonathan: David, because of all the promises made around Social Security, Medicare, and Medicaid entitlement, and all the other things that Uncle Sam spends money on, are we reaching a point of no return?
David: Yeah, if you watch our movie, The Power of Zero, Tom McClintock who is a congressman out of Sacramento, he's a US congressman, he's on the Republican Budget Committee—he was one of the most impressive figures in the movie, by the way, because he has a command of the numbers that really seemed to shine through—and basically he says that you can get to a point of no return because if your debt goes too high, you can reach what's called a sovereign debt crisis. A sovereign debt crisis is just a fancy way of saying, “Hey, other countries are going to stop loaning you money because they don't believe you can pay it back.” When it comes to that, we really start to run out of options in terms of how do we solve this problem because if people aren't going to loan us money, then the only other two ways are you can print money or you can raise taxes. You can't really print money because Social Security, Medicare, and Medicaid are all pegged to inflation, meaning that if we print a lot of money to be able to pay for Medicare, then we basically inflate the money, it increases inflation, that will increase the cost of a doctor's appointment commensurately, and these are all services that people on Medicare are going to have to have is just basic services during their waning years of retirement. You haven't really solved the problem by printing the money. If people will no longer loan us money and we can't print our way out of the problem because all of these programs are pegged to inflation, then what does that leave us with? It leaves us with dramatic and draconian increases in tax rates, the likes of which we probably haven't seen since World War II.
Mark: David, we are talking about all these unfunded obligations of the federal government and the states are not immune to that either, we know there are states who have large unfunded pension programs and other things too, but you've generally talked about what that means in the future in terms of taxes, tell us more specifically what do you think has to happen, particularly federal tax rates to start to work out of this problem?
David: David Walker famously said—and by the way, you'll see that I like to rely on third parties that know a lot more about this than I do, experts like David Walker and Larry Kotlikoff, I'm not an economist but I like to study economist and I like to understand the landscape because 75 million baby boomers are making a bet by putting money into their 401(k)s and IRAs, they're making a bet, whether they realize it or not, that they believe that tax rates in the future are going to be lower than they are today. If they thought that they were going to be higher than they are today and they felt that in their heart of hearts, they would not be putting money into 401(k)s and IRAs, they'd be putting it into the tax-free vehicle. I rely on these third-party experts to really make the case for me, and I think we've done a fairly good job of assembling the case for higher tax rates—David Walker has famously said in a CNN op-ed, I believe it’s in 2009, why your taxes could double. This is the d-word, this is what I call the d-word, double, you'll see we interviewed a lot of people in academia from the most prestigious colleges and universities all across the country, from Northwestern to Boston University, to Berkeley, we interviewed George Shultz, we interviewed the governor of Utah, we interviewed David Walker, all of these people are looking at the same numbers and they’re singing the same song, a lot of them think the tax rates have to double the next 10 years, at the very least, all of them agree that tax rates will have to rise dramatically in the next 10 years and we can't grow our way out of the problem, people aren't going to loan us the money to be able to get out of that problem, that was one of the overwhelming conclusions of the chief global economist from Vanguard, he says, “The one thing I'm very certain of is we’ll never reach $53 trillion or $60 trillion dollars of debt because we would never be able to pay the interest on all that debt.” Something's going to happen to be the straw that breaks the camel's back before we get that much debt simply because, first of all, no one's going to loan us that money, and even if they did loan us the money, we wouldn't be able to afford the interest on it, especially if interest rates return to historically normal levels. We're talking about doubling in tax rates over the course of the next 10 years if we don't start cutting these programs in a dramatic way. It's not like, “Let's shave off a few dollars here and there,” we're talking for every year that we don't cut Social Security, Medicare by a third, the fix on the back end becomes all the more unsolvable. It's pretty dire.
Jonathan: David, as you stated that, it just made me think about some of the conversations we've had with our affluent families and ultra affluent families offices that we serve and most of them do believe that this is impending and the taxes will have to go up, in fact, although you're saying, liberally, I believe 10 years, it could be as soon as the current tax code sunsets and we see that reform in 2026, but most of the alter affluent families we're working with really believe that maybe it’s a change of this administration.
In your book, you talk about three different tax buckets, you talk about the taxable, of course, the tax-deferred, and then also the tax-free, could you tell us what those are and in which ones most American wage earners tend to collect their assets over the course of their lives? Why most trusted advisors in their lives are still teaching them to put money into those buckets?
David: Yeah, as everybody knows, there are millions of different types of investments out there, there are all sorts of different ways that you can save money for retirement, but basically, all of those investments fit into only three types of accounts, I like to refer to those accounts as buckets of money, there are three buckets of money that you can save for retirement, the first one is what we call a taxable bucket, meaning, every year as your money grows, you get to pay a tax. These are going to be like your money market, CDs, savings accounts, brokerage accounts, mutual funds, stocks, bonds, so on and so forth, how can you tell if you have a taxable investment? You receive a 1099 every year for the financial institution that says, “Hey, your money grew this much, now you got to give a portion of that money back to the IRS in the form of taxes.” The 1099 is a tip off. We love to save money in these types of accounts because it's easy, we have liquidity, we can touch the money whenever we want. The problem is this is exactly where the IRS wants us to save our money, this is where the IRS makes the most money, in fact, if you won the Powerball lottery, you could put every last dime of your savings into the taxable bucket, they'd be perfectly okay with it, and they'd be laughing all the way to the bank. This is the least efficient way simply because you give up money to tax every single year. When you amortize that tax inefficiency out over a life, it could cost you a million dollars. We like to use this type of accounts strictly for emergency funds, most financial experts can agree that we should have at least six months worth of basic living expenses in that bucket, but if you start to have too much, I mean you could have more, you have a year, you have two years as long as you recognize that it comes at an expense, whatever dollar you give to the IRS that you didn't really have to give to them, not only did you lose that dollar, but you lose what that dollar could have earned for you over the balance of your lifetime had you been able to keep it and invest it. That's a taxable bucket.
I don't see too many Americans that have lavish amounts of money in that bucket. I occasionally we'll see someone shuffles into my office and they live through the pressure, they say, “Dave, I got nine CDs for nine different banks for $100,000 each and I think I may be paying too much in tax,” and of course they're paying too much in tax because they have way too much money in that bucket. We just have to be sensitive that we utilize this bucket only for emergency funds and really short-term opportunity.
The lion's share of, like I said earlier, $22 trillion of the cumulative retirement savings of baby boomers and Generation Xers across the country are in the second bucket which is what we call the tax-deferred bucket. Now the tax-deferred bucket, you don't pay tax as your money grows, you pay the tax at the very end when you take the money out. That's a little bit scary, so these are your 401(k)s and IRAs, 403(b)s, 457s, annuities, pensions, this can be a little bit scary because what I like to say is when you put money into your 401(k), it's like going into a business partnership with the IRS. Every year, the IRS gets to vote on what percentage of your profits they get to keep, doesn't sound like a very good partnership to me. You could have a million dollars in your IRA, but unless you can accurately predict what tax rates are going to be in the year you take that money out, you don't really know how much money you have. It's pretty hard to plan for retirement if you don't know how much of that money is even going to be available to you, how much money you even own on your retirement years where you're seeking to withdraw those dollars and wring the most efficiency out of your retirement dollars.
The last bucket is tax-free, it's one of my very favorites—I like all of the buckets, I think they all have a purpose, just only in very constrained and particular amounts—the last bucket is the tax-free bucket where you basically choose to pay the tax today, you say, “Hey, look, I think taxes today are going to be lower than they are when I take this money out.” If you believe that in your heart of hearts, you have no business growing and compounding your wealth in the text-deferred bucket. Pay the tax at today's historically low tax rates, get it into the tax-free bucket, and once it's in there, it will grow tax-free and you can take it out tax-free, in other words, you, at that point, have divorced yourself from the IRS. You basically own that money and you have paid the tax on that money, you've divorced the IRS from the whole proceedings, and regardless of what tax rates do down the road, you're always going to have that money.
I tell people all the time, “My goal is to get to the 0% tax bracket in retirement.” Why? Because if I'm in the 0% tax bracket and tax rates double two times, zero is still zero. You notice the title of my book is The Power of Zero, the true power of zero is it insulates you from the impact of rising taxes. If you are in the 0% tax bracket and tax rates double two times, zero is still zero.
Mark: David, in part two of our podcast, we're going to come back and talk more about that second and third bucket, the tax-deferred and the tax-free. For now, for just a minute, let's talk a little bit more about that taxable bucket. What are your general recommendations for how much someone should have in that category? I think you've already talked about the problem of having too much in that category, but maybe just go back over that again too, please.
David: Yeah, this can be a very useful bucket because, like I said earlier, it's very liquid, you can get your hands on it, it makes for a great emergency fund, and really what we're looking for from an emergency fund is about six months worth of basic living expenses. You may have a little bit less if you have two breadwinners in your family, you may want to have a little bit more if you are a business owner and your business is cyclical, and you may want to have a little bit more of a cushion in there. But really, for the most part, six months were the basic living expenses is what we want in those types of accounts, we want it to be relatively low-risk, you don't want to be very risky in those types of investments because if you have an emergency and your investments in that bucket are down 50%, then all of a sudden, you don't really have six months worth of living expenses, you only have three months worth of living expenses. We want it to be liquid and we want it to be relatively non-volatile.
Jonathan: David, thank you. We have a lot more to talk about on this topic in the second part of our podcast and so we're excited about recording that with you. For now, what does Living a Richer Life by Design mean for you?
David: I think it means being more intentional and more proactive when it comes to retirement planning. I think that as Americans, we've been lulled into this false sense of security, we've been lulled into the traditional paradigms when it comes to retirement planning. The traditional paradigm says, “Hey, look, get a tax deduction,” one of the reasons for your 401(k) or IRA is to get a tax deduction, people are going to remember that the primary purpose of a retirement account is not to give you a tax deduction, it's to maximize your cash flow at a period in time when [inaudible 00:25:54] taxes. I love that those two words “by design”. By design denotes some intentionality, some forethought, and some pre-emptive types of strategies. By design is imbued with a lot of meaning, it means that we are looking at the financial landscape, and from a tax perspective, we're trying to get a feel for our tax rates are going to be higher in the future than they are today, and if so, what types of tweaks do we need to make to how we're saving money for retirement? Let's proactively take measures to systematically reposition our assets to tax-free in an effort to insulate ourselves from higher taxes down the road, so a great question and I think that The Power of Zero worldview really embodies that whole “by design” approach.
Jonathan: Absolutely, one of our folks at LionsGate Advisors says, “How can we recapture and redirect funds that were normally being directed to, in our opinion, the most corrupt charitable organization in the world and how to be able to repurpose that for legacy or for tax-free income?” We look forward to our next podcast with you, David. I know that we'll be recording that shortly. Thank you again for listening to Living a Richer Life by Design. For those of you who have joined us today, our goal is to provide our listenership with real-world practical solutions so they can care for the ones they love and also serve those in need. We'd like to give a special thanks again to our today's guest, David McKnight, who will be joining us for part two of this topic on The Power of Zero, we look forward to you joining us for our next episode of Living a Richer Life by Design.
If you're interested in subscribing, please go to lionsgateadvisors.com/podcasts or call 314-222-2788. David, thank you so much for your time today.
David: It's been a pleasure, thanks so much for having me.
Mark: We hope you enjoyed today's show. At LionsGate Advisors, we believe a truly rich life entails much more than financial prosperity, it means crafting a life of purpose and intention. Be sure to subscribe to Living a Richer Life by Design to receive an update when a new episode is published. You can learn more about LionsGate Advisors by visiting us online at lionsgateadvisors.com.