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A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
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Hello there. Welcome to The Power of Zero show. This is David McKnight. I'm the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. As we've announced over the last few weeks, a new book through Penguin Random House will be coming out on February 9th, 2021. We're very excited about that. Of course, we’ll be podcasting about the various subjects that we covered in that book between now and then. If you are looking for a Power of Zero advisor, you can head on over to davidmcknight.com. We're happy to hook you up with a certified Power of Zero advisor that will help you navigate all of the pitfalls that stand between you and the 0% tax bracket. If you're an advisor looking to transition your practice to a Power of Zero practice, head on over to powerofzero.com, opt-in to the video series, and you'll have a chance to talk with us about how we can help you turn your practice into a Power of Zero practice. Also, if you are looking to be able to purchase bulk viewings of our movie, The Power of Zero: The Tax Train Is Coming, you can get those at thetaxtrain.com.
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Today, I'm excited to talk about what I feel like are some great solutions to what has really been some frustrating estate plans for people with large IRAs. Now, remember, historically, people that had large IRAs that didn't want their beneficiaries to spend or squander all of their inheritance all in one year had a way to use a trust to make sure that those IRAs got meted out to those beneficiaries little by little over their life expectancy. Guess what, with the new SECURE Act, those trusts can no longer accomplish that objective. Why? Because the SECURE Act says that no matter what that trust says, your beneficiary now will be forced to spend down that entire IRA in 10 years.
0:02:31
There are some problems with that because you may not feel like the beneficiary of your IRA is at a place in their life where they're going to use that money wisely. They may squander it, may be given up to divorce, or to a lawsuit. There are a gazillion different reasons why people want inheritances to be distributed per the dictates of a trust. Because IRAs have to be spent down in 10 years, that's no longer possible. The question becomes “is there any way to recreate a scenario, an environment if you will, that allows you to continue to control those assets beyond your death, that allows you to rule from the grave?” The answer is there is. There absolutely is a way to do that.
0:03:26
If you read anything by Ed Slott, he wrote an article about it recently, I think that he makes a number of excellent points. What I've long talked about in our podcast is that it may make sense for you to preemptively pay some taxes at your low tax rates while tax rates are historically low, get those dollars repositioned to tax-free. We've talked about how Roth conversions are one way that you can do that. The only problem with the Roth conversion is if your goal is to protect your assets from all of the things that we’ve mentioned—lawsuits and children who may squander your money away—putting it into a Roth IRA is not going to solve that problem because your children or your beneficiaries will get that money over a 10-year time frame regardless. That's not necessarily the solution.
0:04:24
Now, what do we know about life insurance? We know that life insurance can be owned by a trust and that trust can be required by law to distribute those dollars per the language of the trust. There is no requirement for that death benefit to be distributed over 10 years, and because it's in the trust, it's going to enjoy some protections that that trust may not have enjoyed were it wrapped up in an IRA and being distributed per the language of an IRA trust.
0:04:59
The bottom line is life insurance gives us some flexibility in terms of passing money on to the next generation and being able to control how that money gets distributed. This is perhaps how you might go about doing this, instead of preemptively doing Roth conversions with that big IRA that you are planning on handing on to the next generation through a trust that dictated how that money got distributed, you would instead pay taxes preemptively on your IRAs, do it at your tax rates while they’re historically low, and then contribute that money to a life insurance policy that's owned by a trust. Your children can be beneficiaries of that trust but they will not get the money in any other way other than how that trust prescribes it.
0:05:57
Very similar to what we've talked about in the past is that you have a big IRA, you don't feel like you're going to be spending it all during your lifetime, you want to control how that money gets spent once you die, you want to rule from the grave so you would pay taxes on that IRA, do so at your historically low tax rates, get that money into a life insurance policy that's owned by a trust. Then that trust, once you die, can dictate exactly how much money your beneficiaries receive and at precisely what times. These life insurance trusts are much more flexible, they're much more simple, you don't have to navigate a bunch of difficult tax law. That death benefit simply gets distributed at your discretion beyond your death because you dictated exactly how that trust was supposed to distribute that money.
0:06:54
Now, once it's in that trust, the trust will have to pay tax on it so the thing that you have control over is how that money gets distributed, when it gets distributed, and in what amounts. Now it doesn't really solve the problem of how do we get that money to continue to grow tax-free over the course of the beneficiary's lifetime. Because remember, you used to be able to do a stretch Roth IRA and you could take that money out basically, according to your life expectancy, so that money would continue to grow and compound in a tax-free environment over the life of that beneficiary.
0:07:38
The IRS has gotten wise here and they said, “We're missing out on a whole bunch of tax because we're allowing those people to keep that money in that Roth IRA over their lifetime.” That's part of the reason why they are requiring that beneficiaries of Roth IRAs now are going to be forced to distribute that money over 10 years. They're getting it back in circulation. They want to be able to continue to tax that money over and over and over again, unless, of course, you can implement some Power of Zero strategies.
0:08:13
I agree with everything that Ed Slott said in his recent article that talks about how life insurance really is the solution to fix all of these estate plans, all of these people who have historically used a trust to determine how IRAs distribute money once they pass. Life insurance really is the solution, life insurance and a trust that owns that life insurance is going to be the way that people can control how that money gets distributed, in what ways, and what amounts once they die. But it doesn't solve the problem of how do we continue to grow that money in a tax-free way over the life of the beneficiary.
0:08:56
Now, remember, the amounts of money that they're going to be forced to receive over that 10-year period, even if it's a Roth IRA, is a massive, massive amount. Unless they have a plan in place, those beneficiaries are going to be forced to contribute that money to their taxable bucket so that the IRS is going to tax that money over and over and over again as it grows. That's how the IRS is able to take tax-free assets and transform them into taxable assets.
0:09:29
What we want to do is we want to preemptively take a tax-free asset and perpetuate the tax-free nature of that asset. How do we do that? If a beneficiary inherits a huge Roth IRA or even a huge IRA for that matter, they're going to need to have a tax-free receptacle within which to continue to grow that money over their lifetime without paying taxes. Remember, a Roth IRA, you could only contribute to your beneficiaries, they’ll be able to contribute $6,000 or $7,000, depending on how old they are, they could, in theory, move some assets around and maybe recapture that portion of that money, use it to pay for their lifestyle, and then assign a larger portion of their salary to their Roth conversion. But then again, it's $19,500 or $26,000 that they can contribute.
0:10:23
One of the things that we know about life insurance for those beneficiaries is that there is no limit on how much money they can put into that life insurance policy. Now, there may be some underwriting guidelines that say, “Hey, look, the amount you contribute is a function of a death benefit and you can only have so much death benefit.” But what I found is that most people these days, for all intents and purposes, can put in about as much money as they want into permanent life insurance. How does this work? The beneficiary is forced to receive these distributions from either an IRA or a Roth IRA. We prefer it to be a Roth IRA. If we really did good planning on the part of the parent, that money should be in a Roth IRA, or if it's coming through that trust because we put it into a life insurance policy and then it's distributed from the trust, that beneficiary could take that tax-free distribution and put it into permanent life insurance.
0:11:27
There are really three different ways that people can receive this money, it could be through an IRA if they didn't do any planning, it could be through a Roth IRA if they weren't able to qualify for life insurance, or it could be through this life insurance trust. The beneficiary might be getting this money in any of three of those ways. But once they receive that money, they don't spend it, and they don't want to put it in their taxable bucket, then life insurance becomes an excellent vehicle in which to continue to grow those assets in a tax-free way. What do we know about life insurance? We know that you can touch that money pre-59 1/2 without penalty. We know that when you take the money out, if you take it out the right way through a combination of withdrawals and loans or possibly, just through loans, you can take that money out tax-free.
0:12:19
We also know that there are no contribution limits. We know that there are no income limitations so no matter how much money you make, you are not going to be phased out by way of an income limitation to that life insurance policy. We also know that historically, life insurance has been treated with a grandfather clause, in other words, life insurance seems to be immune from what I call tax-rate risk. What's a tax-rate risk? That's the risk we run that somewhere down the road, Congress could change their minds about life insurance. They could say, “Hey, look, we no longer want to protect the inside build-up of tax-free wealth within those life insurance policies, therefore, we’re going to change the rules.”
0:13:09
Historically, every time they've changed the rules vis-à-vis life insurance, they did it in ‘82, ‘84, and ‘88, they simply said, “Whoever has the bucket before the rules changes gets to keep it and continue to put money into it under the old rule for the rest of their lives.” Call that a grandfather clause. Life insurance currently enjoys a number of very positive attributes when it comes to accumulating tax-free wealth. There's a reason that Ed Slott famously said, “Life insurance is the single greatest tax benefit within the IRS tax code.” It gives you more flexibility, it allows you to pass money on to the next generation with more simplicity, it allows you to rule beyond the grave. Once you die, it allows you to call all the shots as to how that money gets distributed. Historically, people have been able to use trusts to manage the distribution of those IRAs. That's become prohibitive because of that 10-year rule and because it's going to force you to pay taxes at a much higher rate.
0:14:14
But also, life insurance is something that I think gets lost in the conversation, how beneficiaries of all of these accounts can use life insurance to continue to grow and compound that inheritance in a tax-free way and use it as a way to possibly supplement their lifestyle tax-free at a period in their lives when taxes are going to be much higher than they are today. Remember, our poor beneficiaries that are going to be receiving this money maybe 10, 20, 30 years from now are going to be inheriting that money at their highest marginal tax bracket at a period in their lives where they're at the apex of their earning years when tax rates are likely much higher than they are today. These folks can least afford to pay the tax. How great could it be if number one, they could inherit that money tax-free through the life insurance, but number two, they could have a way to continue to grow and compound that money over the balance of their life without having to continue to pay tax on it per the IRS’ desires?
0:15:19
I think that we need to heed what Ed Slott said in his recent article which is that we need to start thinking about using life insurance as a more efficient, simple way to bypass the constraints of the SECURE Act, but we also need to use life insurance as a way to continue to grow and compound that wealth for the next generation. In other words, there may be two life insurance policies that need to be purchased, one, now, on the owner of the IRA so that they can do what I call an LIRP conversion, get that money shifted to the LIRP. The only additional layer that Ed Slott recommends here, which I wholeheartedly agree with, is that you have that life insurance retirement plan owned by a trust that can then allow you to distribute that money per your discretion even after you die, but also that we have a second life insurance policy that goes into place after the death of the owner of the IRA so that can now be a receptacle for the distributions that come out of that life insurance trust.
0:16:36
I don't think that if your beneficiary inherits, who knows, I don't know, $100,000 per year for 10 years from that life insurance trust, they may not necessarily need it or want to spend it at that moment in their life. How great would it be if they had a place where they could deposit that money so that it could continue to grow and compound over their lifetime and then create a potentially tax-free benefit for their heirs as well?
0:17:05
The common denominator here is we probably need to be using life insurance more in retirement planning, more in estate planning, and more in the lives of the beneficiaries of those estate plans. Life insurance is so flexible, it offers so many benefits. Is it the only thing that we recommend? No. We recommend it in conjunction with all of the other tax-free buckets that are available. We feel like it makes a lot of sense to have multiple streams of tax-free income, none of which show up on the IRS’s radar, but all of which contribute to you being in the 0% tax bracket.
0:17:37
That's the show for today, folks. Once again, subscribe. By the way, if you haven't had a chance to review any of our books on Amazon, we would really appreciate a review, it really does help. It helps when people pick up our book. They immediately go to Amazon and they say, “How many reviews does this book have? Is it really that mainstream?” If they see 400 to 500 reviews, most of which are positive, it really does help them further embrace the message. That's it for today. I appreciate you carving out a little bit of your day to spend some time with us and we will talk to you next week.
