A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
Hey there. David McKnight. Welcome to The Power of Zero show. Grateful that you're with us for yet another week to learn how to navigate all of the pitfalls that stand between you and the 0% tax bracket. I am the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. As of January 2021, you will be able to find, in bookstores near you, the follow up to The Power of Zero, tentatively entitled Tax-free Income for Life. That will be published through Penguin Random House, the portfolio imprint of Penguin Random House, so I'm very excited about that. The big five publishers tend to move very, very slowly so that’s not something that we can just write in the next couple of weeks and publish overnight, it is a very long, painstaking, and methodical process. I appreciate your patience as we delve into how to mitigate tax rate risk and longevity risk all in the same unified theory. We’ll have more podcasts coming up that discuss more of the content of that book as we approach the ultimate release date and the pre-sales window which should be about three to four months prior to the actual launch week of the book.
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Now, I have gotten a lot of feedback from my podcast last week which was entitled Are We Past the Point of No Return? Is the US debt past in a point of no return? As you know, I am very much into being a clear-eyed realist, if there's something sobering looming on the horizon, we're gonna tackle it head-on. I'm not going to mince words about the fiscal condition of our country. I think that doing so would be a disservice to everyone, to those who are planning on retiring in the next 10 to 20 years, for those who are accumulating their hard-fought savings for retirement somewhere down the road. I got a lot of feedback from people, I said, “Viewer discretion advised,” and they said, “It was a good thing you said that because it very much did require a viewer discretion advised. It's a sobering look at the dismal fiscal condition of our country and where things are headed 10 to 20 to even 30 years from now.”
One of the things that a few people brought to my attention is they said, “Dave, if things are as bad as you say they are”—and remember, it's not me, it's math, the numbers don't lie—“what's to say that me, shifting all this money to tax-free will even do me any good? What's to say that the government won't, at some point in time, just take my Roth IRA away from me? What's to say the federal government won't, at some point in time, take my LIRP away from me?” Now, I'm going to tackle Roth IRAs first and then I'm going to tackle LIRPs. I'm going to talk about why no matter how bad things get, I think that once you have these programs, there's a fair amount of expectation that you'd be able to hold on to them. There's, I think, a small difference between the LIRP and the Roth IRA, we'll get into that distinction here in a moment, but I do believe that once you have these things, you're going to be in decent shape. But let's tackle these things one at a time.
Let's tackle the Roth IRA first. When I say Roth IRA, I'm talking about traditional Roth IRA, I'm talking about Roth 401(k), I'm talking about Roth conversion. Once you have these programs in place, will the government take them away? We have to take a step back and talk about the traditional two approaches that you have to retirement. You have the pre-tax or the post-tax approach. Historically, the federal government has always said, “We are going to tax you either on the seed or on the harvest.” If they tax you on the harvest, this is generally a 401(k) or IRA type approach where they give you a deduction on the front end, your money grows tax-deferred, and then you pay tax on whatever distributions you make on the back end. You do that at whatever tax rates happen to be in the year you make those distributions. That is the tax-deferred approach, that is the pay tax on the harvest approach.
The other approach is to pay tax on the seed, in other words, forgo the tax deduction today, pay taxes at your current marginal income tax rate, put those after-tax dollars into a Roth IRA, Roth 401(k), or Roth conversion, let those dollars grow tax-free, and then you distribute them tax-free. The government is always, basically, saying, “We're going to tax you either on the seed or on the harvest.” In order to tax your Roth IRAs, whether they be Roth 401(k)s, traditional Roth IRAs, or Roth conversions, they would have to completely violate this either/or approach, they would have to blow to smithereens the whole paradigm that says, “We're going to tax you either on your seed or on your harvest.” I think that if they did that, there would be bedlam in the streets.
Number one, I don't think that they're going to do it because it violates the very paradigm that they've forced you to submit to either get tax on the seed or on the harvest. Here's the other thing that we have to always remember, when you add up the cumulative Roth IRAs, Roth 401(k)s, Roth conversions of Americans all across the country, it only adds up to about $800 billion. I know that you're thinking that sounds like a lot of money, it is a lot of money but when you compare it to how many dollars are in the cumulative IRAs and 401(k)s of Americans across the country, it gives you a little bit of pause. Why? Because it's a really, really big number. The amount of dollars in the cumulative IRAs, 401(k)s, SEPs, SIMPLEs, pension plans all across the country is about $23 trillion. It's roughly the equivalent of our national debt.
What would be easier for them to do? Would it be easier for them to violate a principle that they've forced you to submit to all of these years, i.e. either get tax on your seed or on your harvest, or would it be much easier for them to simply ignore the money that's in the cumulative Roth IRAs which doesn't amount to much? If we're talking about the ratio between tax-deferred to tax-free, it's like a 25:1 ratio. Why would they mess with the 4% of America's assets, cause all sorts of voters to get upset because they had the rug pulled out from under them, and it was a bait-and-switch on the part of the IRS? Wouldn't it be much easier for the IRS to simply do what they've done in the past, namely to raise taxes on that pot of money that are owned by the people with whom they're in a business partnership? It's legal, they've done it before, and as money grows in shorter and shorter supply, they are likely to do it again. As they raise income tax rates, they are decreasing your percentage share in that business partnership. Every time they raise taxes, your portion that you own of that IRA and 401(k) diminishes. That is the likely approach.
Now, I'm not saying that if you have a Roth IRA that they will allow you to contribute to that thing ad infinitum simply because you have it. They will most likely allow you to keep what's in there tax-free, allow it to continue to grow and compound in a tax-free way, there's a possibility that they could prevent you from continuing to contribute to it. I'm not ruling that possibility out but I would be very, very shocked, for those people who already had money in Roth IRAs, if they decided to tax those. It's just too much of a risk. It would cause bedlam in the streets, it would create an entire block of voters that have become dissatisfied and have this feeling that they had a bait-and-switch.
Let's talk quickly about LIRPs. LIRPs, I believe someday, will be taken away. Why? Because as a country slides further and further into insolvency and as they get to the point, as we discussed last week, where they're past the point of no return, I think that our federal government will be looking in all quarters for more revenue. They already almost took away the LIRP a couple of years ago when they were trying to raise the debt ceiling. They basically said, “We are only going to raise the debt ceiling if we can free up some spending to offset the increase in the debt ceiling.” I think it was a Simpson-Bowles committee, they got together and they made a bunch of different recommendations but they couldn't get everybody to agree upon them. One of which was to tax the inside build-up of life insurance.
Now as then days past, every single time, and as recently as, I think it was 2005, maybe it was 2003, President George W. Bush came out with a recommendation to make the tax code more uniform and to level the playing field for everybody. One of the things that they said was people can have nearly unlimited tax-free benefits due to certain life insurance arrangements. We recommend that these arrangements be taxed as normal savings accounts. However, and this is the big grandfather clause at the end, anybody who has these programs in place before the rule changes gets to keep them and continue to contribute to them under the old rule for the rest of their lives.
This is the grandfather clause and this is what's key, the key is that every single time that they've changed the rules—and they changed them three times in ‘82, ‘84, and ‘88—they simply said, “Whoever has the bucket gets to keep it and continue to put money into it under the old rule for the rest of their lives.” This is a pretty key distinction between the Roth IRA. The Roth IRA, they will likely say, “You get to keep it but you don't get to continue to put money into it for the rest of their lives.” With the LIRP, if history serves as a model, they'll say, “You get to keep it if you already have it and you get to continue to put money into it under the old rule for the rest of your lives.” Why? Because some life insurance arrangements, in order to stay solvent, require ongoing contributions, depending on how you structure it, that's not how all of them work.
A lot of the LIRPs, for example, that we structure, you may max out your contribution after five years or you may max out your contributions after seven years or ten years. But in general, life insurance policies work best if you have the ability to continue to put money into them. They would not likely change that. What this does is it creates even more urgency for those who are contemplating it in LIRP, they do not have an LIRP yet to get one, to get it secured, and to get it in place before they take it away somewhere down the road. I am convinced that somewhere down the road that they will simply because they can't allow these massive, massive, what Ed Slott calls the greatest tax benefit in the US tax code is the tax benefit for life insurance.
If a country is going broke as we are, they will not allow these benefits to persist in perpetuity. It's just a question of time before they take it away. This much we know if history serves as a model, if the past is prologue, we will be able to continue to not only keep these programs but to continue to contribute to them through the balance of our lives and our children will continue to be able to receive the tax benefits or the death benefits completely tax-free.
In summary, I don't want you to fret too much as a result of my podcast last week. I want you to be absolutely clear-eyed and sober about what is facing our country but I also want you to recognize that I feel like there are some places where you can safeguard your money against the inevitable rise and dramatic rise in tax rates in our country. Grandfather clause is your friend. Remember that historically, life insurance has been grandfathered, Roth IRAs are likely to be grandfathered, but the big distinction there is you probably won't be able to continue to contribute to them in an ongoing way.
That is the podcast for today. Again, please subscribe. If you subscribe, you will get an email to your inbox telling you, through whatever medium you prefer listening to podcasts, that our new episode is available and telling you exactly what it's going to be about. Thanks again for tuning in. We will look forward to chatting with you at the same time next week. Talk to you soon.