A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
Hi there. David McKnight. Welcome to The Power of Zero show. So grateful that you're with us for yet another episode. As you know, I am the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. You can buy all of those books in bulk at powerofzero.com/Books. You can also watch my movie The Power of Zero that I made together with filmmaker Doug orchard, The Power of Zero: The Tax Train Is Coming. You can stream that anywhere movies are streamed. If you are a financial advisor and are looking to convert your practice to a Power of Zero type practice, you can go to powerofzero.com and opt-in to our video series. If you are simply listening to the podcast trying to figure out how to navigate your way to the 0% tax bracket, by all means, reach out to us at davidmcknight.com and we'll try to find some certified Power of Zero advisor to connect you with. Of course, you can always follow me on Twitter @mcknightandco. As always, I am ever grateful for those of you who write reviews about any of our books on Amazon, it really does help.
There's a lot of different people out there that have come up with their version of the 12 rules. I think Jordan Peterson’s 12 Rules for Life probably made this famous and a number of people have actually followed suit. I'm going to lay out for you what I believe to be are the 12 rules for a Power of Zero retirement. I think I can spend only about one minute on each one so you're going to get out of here in roughly 12 minutes or so. Let's jump right in.
First rule for a Power of Zero retirement is everyone's situation is different, there is no cookie-cutter approach. Now you’re thinking, “Dave, this sounds like there are no rules. You just told me that there are 12 rules, now you’re telling me there are no rules,” no. I'm telling you that everybody has to operate within a given set of Power of Zero rules, however, everybody's going to be a little bit different so you can't pick up The Power of Zero book and all of a sudden, you have the recipe to get to the 0% tax bracket, because everybody is so different, everyone's situation is different, you might have a pension, you might not have a pension, you might be ten years pre-retirement, you might be retiring tomorrow. Everybody's different and everybody calls for a different strategy, there are no cookie-cutter approaches.
Number two rule for a Power of Zero retirement: You are not likely to be in a lower tax bracket in retirement. In fact, the closer you are to 2029, the less likely you are to be in a lower tax bracket in retirement. I've often said that people used to say, “Hey, Dave, when are tax rates going up?” Who knows? Maybe 10 years from now. We know that given what's happening with the sunsets of the Tax Cuts and Jobs Act reduction in taxes, we know that tax rates are going to go back up in 2026, and frankly, that should give motivation to everybody to act and get dollars repositioned to tax-free but I am not nearly as worried about 2026 as I am 2029, 2030, and beyond. I think that when we look at this ten-year horizon, it's really tough to make the case that tax rates won't be substantially higher ten years from now than they are today and I think that was really borne out by our experts in The Power of Zero: The Tax Train Is Coming movie. This whole notion that you could be in the 0% tax bracket, you have to banish that from your vocabulary. The rule for Power of Zero is that you will likely be in a higher tax bracket. Again, revert back to number one, everyone's situation is different, there are always exceptions to these rules, but for the most part, you are likely to be in a higher tax bracket in retirement. Of course, that turns conventional wisdom on its year, we've always been told just the opposite but we're marching into a future that's very, very uncertain where our fiscal condition of our great nation is very, very unstable and unpredictable and this does not bode well for people who have the vast majority of their assets accumulated in the tax-deferred bucket.
POZ rule number three: There is an ideal balance to have in your first two buckets in a rising tax-rate environment. Remember, we want the ideal balance in your taxable bucket to be about six months worth of basic living expenses and we want the ideal balance in your tax-deferred bucket to be low enough that required minimum distributions in retirement are equal to or less than your standard deduction but also low enough that they don't cause Social Security taxation.
Rule number four, anything above and beyond the ideal balance in those first two buckets should be systematically repositioned to tax-free. Remember, you don't want to do it all at once, you don't want to rise too dramatically in your tax cylinder that's going to give you heartburn but we want to do it slowly enough that we don't rise too dramatically in your tax cylinder like I said, but quickly enough that we do get all the heavy lifting done before 2026 rolls around. Did you know that if you are shifting to the top of the 24% tax bracket, that 24% becomes, I believe it's 34% once 2026 rolls around? That's pretty substantial tax saving. That's why chapter 6 in my updated and revised version of my book is entitled The Tax Sale of A Lifetime because this really is an unprecedented opportunity to take advantage of historically low tax rates.
POZ rule number five: Anything with the word Roth IRA on it is your best friend. We love Roth IRAs, we love Roth conversions, we love Roth 401(k)s; any word with the Roth on it, we love. These investment vehicles give you the ability to shift nearly unlimited amounts of money from tax-deferred to tax-free. They all have different features that are great. The traditional Roth IRA gives you access to that money, your principal from day one, very few of the other tax-free investment streams of income allow you to do that. The Roth 401(k) gives you free money typically if you're in a company that offers you a match, most people are, so you get to put money into your Roth 401(k) and get free money along the way. It's hard to beat that. Then, of course, the Roth conversion is great because it allows you to shift nearly unlimited amounts of money from tax-deferred to tax-free and to do so at historically low tax rates.
POZ rule number six—I told you we'd be blazing through these today—Social Security taxation is a big deal. You want to do everything that you can to try to get your Social Security tax-free. Why? Because if you give up 25% of your Social Security to taxation because you got all this provisional income that you didn't otherwise know about, now you've got to spend down all your other assets in the meantime to compensate. I give this example all the time, if you have a $5,000 hole in your Social Security because of Social Security taxation, and tax rates went up to 50%, like David Walker is calling for or predicting, how much money would you have to take out of your IRA or 401(k) to be able to pay that 50% tax to the IRS and then be leftover with $5,000 with which you can then plug the hole in your Social Security? About $10,000. Folks, I bring this up because we've been studying this for a very long time. We've done the math on hundreds and hundreds of clients and we've noticed that when your Social Security gets taxed, it has an adverse effect on how long your money lasts, in many cases, your money runs out five to seven years faster than those who do not have their Social Security taxed. Keep your eye on the ball when it comes to Social Security taxation. It's a really, really big deal if you are in the Power of Zero paradigm, you're constantly asking yourself, “Is this going to cause Social Security taxation?” Is my balance in this account too high such that I will flip the trigger that causes Social Security taxation? How can I minimize Social Security taxation?
POZ rule number seven: Remember there are exceptions to all these rules, the best way to deal with long-term care in retirement is not with a traditional long-term care policy but is most likely through a life insurance retirement plan (LIRP). Why? Because if you're dealing with traditional long-term care, you're paying for something you hope you never have to use, at least, with the LIRP. If you die peacefully in your sleep 30 years from now never having used it, somebody's still getting a death benefit at the end. In the meantime, your money grows safely and productively and it grows tax-free. You've got this great death benefit that can go to your heirs if you should die peacefully in your sleep never having needed long-term care. LIRPs really are a great, great way to take the sting out of mitigating the long-term care risk.
POZ rule number eight, you will need more than just one stream of tax-free income in retirement and the more streams of tax-free income you have, the better. I get the willies when people say, “Hey, look, I got all my eggs in the LIRP basket or I've got all my eggs in just the Roth IRA basket,” folks, you want to have all sorts of different streams of tax-free income, you never know when the IRS is going to legislate one of your tax-free streams of income right out of existence so it's really good to have a bunch of buckets on the table, all of which are tax-free, none of which show up on the IRS’ radar. They're working in concert with each other, I've talked about it as pieces of a puzzle, when they fit together perfectly, the 0% tax bracket comes into focus.
POZ rule number nine: You really do want to get all your heavy lifting done before 2026. 2026 is a magical deadline in the POZ paradigm. If you're going to be shifting assets from taxable and tax-deferred to tax-free, you want to get it done before 2026, it just makes sense, you have seven years. Here we are approaching the end of 2019 so you got to get your ducks in a row before the end of the year, so we got 2019, 2020, 2021, 2022, 2023, 2024, and 2025, that's seven years, and if you let a year go by where you're not taking advantage of these low tax rates, what happens? Then you have more to shift in a shorter amount of time which means you run the risk of potentially rising higher in your tax cylinder than you really want to and starting to clip into some of these higher tax brackets that you're really hoping to avoid so let's get all the heavy lifting done before 2026, can we?
POZ rule number ten: Know your magic number. If somebody wakes you up in the middle of the night, puts a gun to your head and says, “What's your magic number?” you should be able to spit it out, what is your magic number? If you don't know what your magic number is, I talk about your magic number in chapter six of the updated and revised version of my book The Power of Zero, I also talked about it on my davidmcknight.com website, we have a calculator there, your magic number is how much you should be shifting each and every year from your taxable and tax-deferred buckets to tax-free such that by the time 2026 rolls around, you've got everything perfectly allocated in all the right buckets. Remember what is distribution planning? This is what it's all about, distribution plan is making sure you have the right amounts of money in the right type of bucket so that in retirement, you can distribute those dollars in the right way so that you can maximize, you wring every last bit of efficiency out of your retirement dollars. You only have so many retirement dollars, you need to spend them in the most tax-efficient way possible.
POZ rule number eleven: Never ever annuitize your retirement in the tax-deferred bucket. Remember, if you annuitize an investment out of the tax-deferred bucket, it's going to feel like a distribution from an IRA, it's going to be treated as ordinary income. As tax rates go up, the portion that you get to keep goes down and you're going to have to spend down all your other assets to compensate, not only that, but the income that comes out of an annuity from the tax-deferred bucket counts as provisional income, it will cause Social Security taxation and then to make up for that hole in your Social Security taxation, you're going to have to spend down all your other assets that much faster. So it's a double whammy when you have an annuity and that doesn't mean you can't have an annuity in your tax-deferred bucket, it means you don't want to annuitize your investment. When you annuitize your investment, you can't go back, you pass the point of no return, you're stuck with it. It's like making an election on your pension, once you elect a certain stream of income from your pension, there's no walking it back. The only time I would say you might be able to annuitize something out of the tax-deferred bucket is if the annuity that is coming out of there is less than or equal to your standard deduction and also low enough that it doesn't cause Social Security taxation, otherwise, you have no business electing an annuity or annuitize an investment from the tax-deferred bucket, especially when there are ways to get that money systematically repositioned to tax-free so that you can take that money out and annuitize it out of the tax-free bucket and eliminate longevity risk, eliminate all of the other risks that are impacted by longevity risk.
Twelve rules for a POZ retirement, rule number twelve: It is much better to have a guiding hand when you're navigating the path to the 0% tax bracket. There are 12 ways from Tuesday to get this wrong. If you have too much money coming out of your tax-deferred bucket, it could affect the threshold on one hand that automatically flips a switch on the other hand, then all of a sudden, you're not in the 0% tax bracket, you've got all these different thresholds, you've got the provisional income threshold, you've got the RMD threshold, you've got the standard deduction threshold and these are always changing. Remember, in 2026, the standard deduction threshold is going to change, so these things are always changing so you want an experienced hand on the tiller, you want someone that has been down this road before, understands the pitfalls, understands the roadblocks, can help you circumnavigate them.
Again, if you find yourselves in a position where you would like some help in navigating the path to 0% tax bracket, please, by all means, reach out to us at davidmcknight.com and we will hook you up with an experienced certified Power of Zero specialists. That's it for today, folks, that's 12 rules, hopefully, I kept it under 12 minutes. Remember, if you want to follow me on Twitter, feel free to do so, it's @mcknightandco. You can buy our books in bulk at powerofzero.com/Books and you can stream the movie, The Power of Zero: The Tax Train Is Coming anywhere that you stream movies. Thanks for being on the show today and we will look forward to talking to you next week.