A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
Hello there. David McKnight here with The Power of Zero show. I hope you're doing great. Thanks for carving off a little portion of your day to learn more about The Power of Zero paradigm. Once again, I am the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. I'm happy to report that coming in January of 2021, I've just signed an acceptance offer with Penguin Random House to do a follow-up book on The Power of Zero. It's going to really draw everything into one unified strategy so that you understand exactly how all your money is going to be working in a cohesive and unified way to get you to the 0% tax bracket, to help you mitigate tax-rate risk, longevity risk in a very, very satisfying and unified way. You're really going to want to look out for that.
Unfortunately, these things just take a really long time. I'll probably have the book finished in the next couple of months, it's already completely outlined, I know exactly what every chapter says. But Penguin Random House, they're a big five publisher and they move at a snail's pace, which I suppose is good because they don't want to just throw something out there after having worked on it for a month. They're very methodical, they want to make sure that everything is perfect before they roll it out to the world. So be looking for that January 2021. Of course, I'll be podcasting about a lot of what we talk about on that book between now and then.
If you are looking for copies of any of my books, be it The Power of Zero, Look Before You LIRP, or The Volatility Shield, you can get those at powerofzero.com/Books. I would really love it if you gave me a follow on Twitter, it's at @mcknightandco. Last but not the least, would love it if you put some reviews of our books online, they really do help, they really do help people who are checking our books out online understand that they need to take our book seriously because there are a lot of positive reviews.
One other thing, Doug Orchard, the director of The Power of Zero: The Tax Train Is Coming is rolling out his offer to be able to buy bulk amounts of streamings of the movie. You can buy 400 a time for $5 per stream. You can post those on your website. You can send them out to friends, clients, or what have you, and they can actually watch the movie. As they watch the movie, your view count goes down, then he lets you know when you hit about 50 or so. You can go to thetaxtrain.com to learn more about that.
We are in the new year and with the new year, of course, comes important changes to the IRS tax code, to income limits, to contribution limits, to all the various thresholds that we have to know about when it comes to The Power of Zero plan. Remember, when it comes to The Power of Zero, you have to know what these different thresholds are because you could violate a threshold, on the one hand, that forces you to pay a tax on the other hand. You have to be keenly aware of all these little pitfalls that are more like landmines that are scattered all over the place. Of course, we’re here to help you circumnavigate those pitfalls in those landmines.
First of all, let's start off with the Roth IRA. The new income threshold at which points your ability to contribute to Roth IRAs gets phased out, it's now for a single person, it's $124,000 to $139,000 and for a married couple, it's $196,000 to $206,000. Now, remember how this works is let's say you’re a married couple and you have an income of $201,000 modified adjusted gross income. Because you're halfway through that phase-out range, remember, it's $196,000 to $206,000, you are $5,000 into that $10,000 phase-out range, your ability to contribute to the Roth IRA gets cut in half both for you and for your spouse. Instead of being able to contribute $7,000, you and your spouse would only be able to contribute $3,500 each. That's how that phase-out works. Be aware of that as you're contemplating, I know it's tough to even figure out ahead of time what your income is going to be in a given year.
The nice part about the Roth IRA is you have up until April 15th of the following year to figure out if you're going to contribute so you can get a fair idea of what your modified adjusted gross income is going to be and whether you're violating any of these thresholds or not. I wish I could say it was that easy for the Roth conversion. With the Roth conversion, you have to decide whether you're going to do it before December 31st and if you guesstimate, and sometime in January said, “Man, I wish I didn't do that,” you can no longer go back in time and change that. You can no longer go back and modify your tax return and recharacterize that Roth conversion.
You have the onerous task of trying to figure out if a Roth conversion is, number one, something you should do, number two, up to what income tax bracket should you be converting in order to maximize that Roth conversion in any given year.
Let's move on to 401(k)s, this has changed a little bit. If you're younger than age 50, you can now contribute $19,500 which is up from $19,000 in 2019, or you can contribute $26,000 if you're over age 50. That's up from $25,000 in 2019. These are positive things, especially when you consider that that applies to the Roth 401(k) as well. You can now contribute massive amounts of money to these tax-free vehicles which I obviously, encourage that you do. I'm, as you know, a big fan of Roth IRAs, Roth 401(k)s, Roth conversions, anything with the word Roth in them I think is something you should take a look at given what we talked about last week, we're marching into a financial apocalypse.
I don't want to try to overstate my case here but we are marching into a future that looks very, very grim, very, very daunting, and very, very sobering. The least you can do is try to protect yourself from the impact of tax-rate risk because tax rates are likely to rise dramatically even in the next 10 years. Make sure you're protecting yourself by taking advantage of many of these diversified streams of tax-free income as possible.
Let's move on to the standard deduction. Standard deduction for single folks went from $12,200 to $12,400 and for married couples, that went from $24,400 to $24,800. Now, remember what happens in 2026. In 2026, we are going to revert to the tax code of 2017 which means that the personal exemption comes back, the standard deduction goes down. I wouldn't worry about this too much because remember, in 2018, when we lost the personal exemption and the standard deduction went up, the net increase and benefit to you of deductions was not all that much, the real benefit of the tax code came in the massive expansion of those lower tax brackets, being able to fit much more income into some of these lower to middle-income tax brackets, meaning you save more when it comes time to doing Roth conversion.
My prognostication here is that come 2026, they will simply revert back to the standard deduction and the personal exemptions from 2017, they will index them both for inflation to cover those eight years and you will end up with standard deductions and personal exemptions roughly equal to what the standard deduction would have been had they simply extended it from 2025 to 2026. I wouldn't lose too much sleep over at that.
Of course, you still get an additional standard deduction if you are full retirement age so that gets even better and if you were blind, you also get that same deduction. None of those have changed. It’s very, very important that you understand what's going on with the RMDs. Previously, we know the RMD was you had to draw your RMD by April 1st following your 70 1/2th year, now it’s moved back to age 72. What does that mean? That means you have to draw your RMD by April 1st following the year in which you turn 72. What does that mean? That means that you are, for all intents and purposes, postponing those RMDs for two years.
This is going to not be a big deal for people who really need the money, in other words, if you really need the money at age 70 1/2, you're going to withdraw the money anyway at age 70 1/2. Where this becomes potentially what can perceive to be a benefit is for people who don't need the money, maybe they get pensions and Social Securities that cover their lifestyle needs, they're not going to be forced to realize that income during those two years they might otherwise have. However, you got to remember what the flipside here is. The flipside is that their IRAs could be even bigger by the time they draw those down and the rate at which they're going to force you to draw those down is going to be even bigger. If it's two years further into the future, I think that's two years more likely that tax rates could be higher for you.
Whereas previously, when you were in your 70 1/2 year, you were taking money at 3.65%, we are now going to be forced to take money at, I think it's about 3.906%, I'm rounding up to 3.91%. You’re going to be forced to take 3.91% of your IRAs and 401(k)s by April 1st following the year in which you turn 72. They're going to force you to take more out, your IRA will have grown to a larger amount, there's a higher likelihood that taxes could be higher down the road. I don't know quite how to interpret this for you, you may be thinking, “Hey, this is great news,” I don't know. I just know that when you are going to be taking this out, you’re going to be taking out a higher percentage on, probably, a higher amount of money potentially, with higher taxes.
We also know that the stretch IRA has been abolished. Your non-spouse beneficiaries, meaning your children, are going to be forced to spend down your IRAs, 401(k)s, and Roth IRAs in the 10 years following your death. This is a huge deal we've talked about in the past podcasts, all the more reason why you should be shifting money in the tax-free accounts like Roth conversions and life insurance because first of all, the life insurance, they won't be forced to spend that down but a Roth conversion, when they inherit that, even if they are forced to spend it down, they could then contribute it to their own Roth IRAs, their own LIRPs, what-have-you, and continue to get tax-free growth on that and they're not going to have to pay taxes on top of all their other income at the apex of their earning years.
Pay taxes at your historically low tax rates so that they don't have to pay taxes at their historically high tax rates over a 10-year period of time. Remember, if you have $1 million grown at 6.5% per year and your kids have to spend that down in 10 years, that's about $125,000 per year if they were really trying to spread that tax liability out over 10 years, $125,000 per year over 10 years, big deal. Make sure you're on top of your Roth conversions if you believe that tax rates today are lower than they will be in the future.
We also know that you can now contribute to IRAs after age 70 1/2 so for those of you who love to take advantage of the backdoor Roth conversion where you're contributing a non-deductible contribution to your IRA and then converting it to a Roth IRA with the stroke of a pen, maybe the very next day, you can now do that after age 70 1/2, you couldn't do that before. A lot of people thought you couldn't contribute to a Roth IRA after 70 1/2, you could always contribute to a Roth IRA after 70 1/2. It was the IRA that you could not contribute to after 70 1/2, and now you can.
Estate tax exemption is now at $11.8 million per individual up from $11.4 million in 2019. Keep in mind that these are some pretty rich benefits, and to think that under Reagan, $625,000 was the estate tax exemption and that was hardly anything back in the day. Now you can contribute per couple, we're talking $22 million, $23 million that you can pass on to the next generation without any estate tax at all. That is a massive amount. This is I think, for all intents and purposes, a giveaway. I'm not sure that all of these risk-tax benefits will persist given a change in administration in 2020, but remember, what would have to happen is democrats would have to get a hold of the House, the Senate, and the presidency to change a lot of this stuff.
Is that possible? Certainly. But I think it would take a lot, I think it'd have to take a lot of alignment of the stars for that to happen. People write me all the time, “Hey, Dave, you say tax rates won't change until 2026, what happens if there's a change in regime, change in administration in 2020?” Certainly, that can happen, I just think the likelihood of that happening is not very high, especially given the numbers in the Republican Senate right now.
One other thing, the annual gift exclusion is holding steady at $15,000 per person for 2020. Between you and your spouse, you could contribute, if you do gift splitting, $30,000 to each person that you want to gift money to. It could be a kid, it could be a cousin, it could be a stranger, it could be anyone, but that's $30,000 per couple.
I think that these are all positive things. One question I really have for the IRS is why, for example, do you raise the contribution limits for 401(k), $500 pre-age 50 or $1,000 post-age 50, yet you don't touch the Roth IRA contribution thresholds or limits? I don't know if the IRS is using some sort of algorithm behind the scenes to figure out what they should be doing. I do know that if they have not increased your ability to contribute to a Roth IRA, in my mind, what that tells me—and I may be wrong in this—but what it what I think it tells me is that the Roth IRA is a good thing. I've talked about this in The Power of Zero that anytime the government puts limits on contributions to certain types of accounts, that tells me it's a good thing. They have not adjusted your ability to contribute to a Roth IRA to keep up with inflation. That tells me, and that should tell you, that Roth IRAs are good things.
This is most of what you should know for 2020. If you're a financial advisor, I think these are all thresholds and limits that you should be memorizing. Your clients deserve to know exactly what these thresholds are. I think that by understanding these thresholds, you can really maximize your contributions to these types of accounts.
Remember, I love all things tax-free. My ideal approach to tax-free retirement says “Take advantage of all the tax-free streams of income that are available to you because they all have benefits and merits that are unique to each little bucket we're putting on the table here.” Roth 401(k)s have unique qualities that Roth conversions don't. LIRPs have unique qualities that Roth IRAs don’t. Taking money out of your IRAs up to standard deduction and personal exemptions without causing Social Security taxation, those tax-free RMDs have merits and unique qualities that none of the other ones have. Remember, we're trying to fit pieces of a puzzle together to find the 0% tax bracket. As you put these pieces of the puzzle together and they fit perfectly and seamlessly together, then the 0% tax bracket comes into focus.
That's the show for today, folks. Subscribe. Again, if you need books, go to powerofzero.com/Books. If you want to watch our movie, go to thetaxtrain.com. Of course, please follow me on Twitter and put reviews on Amazon. We would really love it if you did. We will talk to you next week.