Tax rates 10 years from now are likely to be much higher than they are today. Is your retirement plan ready? Learn how to avoid the coming tax freight train and maximize your retirement dollars. 276095
Tax rates 10 years from now are likely to be much higher than they are today. Is your retirement plan ready? Learn how to avoid the coming tax freight train and maximize your retirement dollars. 276095
How Life Insurance Will Replace the Stretch IRA with David McKnight
Historically, people who had large IRA’s, and who didn’t want their beneficiaries to squander their inheritance all in one year, could use a trust to make sure the funds were released over the course of their lifetime. However, due to the recently passed Secure Act, that beneficiary will be forced to spend down that money over ten years or less.
The good news is that there is a way to control the flow of money in a similar fashion despite the legislation.
Since it makes sense to pay taxes now while taxes are still currently historically low, Roth conversions are one way you can do that, but Roth IRA’s won’t solve the inheritance problem. This is where life insurance comes in.
We know that life insurance can be owned by a trust, and this trust can be required by law to distribute those dollars per the language of the trust. 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.
Instead of preemptively doing Roth conversions with a large IRA, you would instead pay taxes preemptively at historically low tax rates, and then contribute that money to a life insurance policy that is owned by a trust. Your beneficiaries will not get that money in any other way than the way the trust prescribes it.
Life insurance trusts are much more flexible and simple, and you don’t have to navigate a bunch of difficult tax laws.
As great as this strategy is, it doesn’t solve the problem of keeping the money growing tax free over the life of the beneficiary in the way it would with the previous form of the stretch IRA. The IRS is getting wise and is now requiring beneficiaries of Roth IRAs to spend that money down over the course of ten years.
If a beneficiary inherits a huge IRA or Roth IRA, they will need a tax-free receptacle within which they can continue to grow that money tax-free over their lifetime. One of the things that we know about life insurance is that there is no limit on how much money that you can put into the policy.
Ideally, the beneficiary is forced to receive these distributions from a IRA or Roth IRA, or from a trust that owns a life insurance policy, and once received that money is placed into another life insurance policy since life insurance is an excellent vehicle for assets to continue to grow in a tax-free way.
We know that you can touch that money in the life insurance policy before age 59 and a half without a penalty. When you take the money out the correct way, it can be tax-free and there are no contribution limits. We also know that life insurance has been historically granted a grandfather clause. Life insurance seems to be immune to tax rate risk.
If congress decides that someday in the future they want to change the rules around life insurance, existing policies will be exempt and continue operating under the old rules.
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, and allows you to rule from beyond the grave.
The fact that beneficiaries can use life insurance to continue to grow and compound their inheritance in a tax-free way is often lost in the conversation. We need to start thinking about using life insurance as a more efficient way to bypass the constraints of the Secure Act while also using life insurance as a way to grow and compound that wealth for the next generation.
There may be two life insurance policies that need to be purchased, one owned by a trust that allows you to distribute that money at your discretion, and a second policy owned by the beneficiary for use as a receptacle for that money.
The common denominator here is that we probably need to be using life insurance more in retirement planning, more in estate planning, a
Is The 4% Rule Still Viable? with David McKnight
The 4% Rule originated with a man named William Bengen in 1994. He looked back and noticed that people were withdrawing from their portfolios at a very haphazard rate. Prior to 2005, a common way people used to determine how much they could withdraw was to look at the average return of the market at the time.
When asked, 40% of retirees said that they could withdraw 10% annually from their portfolio starting from day one of their retirement without ever running out of money.
William Bengen started running Monte Carlo simulations on the past 70 years and used a hundred thousand combinations of variables including length of retirement, rate of withdrawal, and stock mix. He found that the current rates of distribution of 7% at the time were completely unsustainable, and that the only way to give yourself a high probability of having your money last through life expectancy was to take out 4%, hence the 4% Rule.
If you have a million dollars starting day one of retirement and wanted to keep up with inflation over time, the most you could take out was $40,000. Over a 30 year retirement, you would have a 90% likelihood of your money lasting your whole lifetime.
This became the way that most people combatted longevity risk. As long as you only took 4% of your retirement portfolio adjusted for inflation, that gave you a very high probability of your money lasting through a 30 year time period.
When William formulated his 4% Rule, he was using a 40/60 split between stocks and bonds, but bonds are no longer performing the way they did in the 90’s. Many economists and retirement experts have revised the rule downwards primarily as a function of bond returns.
Combating longevity risk is an expensive proposition, even if you use the 4% Rule. If you require $100,000 to live in retirement, once you factor in inflation you will need roughly $2.5 million by the time you retire. If you’re not on track to hit that amount in your portfolio, you have five heartburn inducing alternatives: save more, spend less, work longer, die sooner, or take more risk in the stock market. It gets even worse with the new 3% Rule.
With the 3% Rule, what was before a very expensive, cash intensive, high asset proposition is now even more expensive. You need even more money if you plan on using the stock market and the 3% Rule, even if you manage to acquire enough money it’s not guaranteed.
The second issue with the 4% Rule is you have to be able to stick to it even in erratic markets, which is the opposite of what most people do. In order for the Rule to work for you you have to keep your money invested in good and bad markets. Do you have the discipline to keep your money invested even when the market is going down?
There is also the illusion of liquidity. When you have millions of dollars in your retirement portfolio, it looks like you have plenty of money that’s easily accessible. The trouble is that every single dollar is already earmarked under the Rule and as soon as you take out any additional funds your odds of outlasting your retirement money sink rapidly.
If your plan is to live by the 3% Rule, all your retirement money is already allocated and you won’t have any room for unexpected expenses. If you want to be able to cover shock expenses or aspirational goals, you will need an additional fund set aside by the time you retire.
We have to be clear about the shortcomings of the 4% Rule, and now the 3% Rule as well. They work in a vacuum, but we don’t live in a vacuum. We live in the real world and unexpected things happen.
The Difference Between Tax-Deferred and Tax-Free with David McKnight
David gets the same question nearly every single week. Someone invariably asks about how if they do a Roth conversion, won’t they have less money working for them in the tax-free bucket and need more time to catch up compared to had they just left the money in the tax-deferred bucket?
If the government came up to you and offered to loan you some money and wouldn’t tell you what the interest rate will be, would you cash the check? Putting money into your 401(k) is very similar, by doing so you are letting the government tell you what the rate will be once you want to take out that money.
According to the publicly stated debt, we are $23 trillion in debt but according to fiscal gap accounting we are $239 trillion in debt. Listen to episode 63 of the Power of Zero podcast to find out how dire the situation actually is. The question is why are Americans still okay with that deal?
David breaks down the math and compares two scenarios. One person has $1 million in an IRA and another does a Roth IRA and has $700,000 in their tax-free bucket. The question is which person has more money?
The thing that people forget is that when you have money in an IRA you have a business partner, and until you distribute money from that bucket, you don’t know how much you actually have.
Assuming a level tax rate environment, both people have the same amount. But there are other considerations, the person taking money from their tax-deferred bucket is going to take distributions that will count as provisional income, which will cause their social security to be taxed. The person taking money from their tax-free bucket doesn’t have to worry about that.
If tax rates go up by 1%, the person with the Roth IRA will definitely have more money. A Roth IRA gives you certainty and creates an environment where you reasonably expect to know the amount of money you will withdraw into retirement. You won’t have to roll the dice and hope that tax rates stay low as our country slips into insolvency.
The January 28th edition of the Wall Street Journal goes through all the Democratic candidates and their tax plans. The nature of political power is to swing back and forth, and since that’s the case we are very likely to see marginal tax rates go up in the future simply because of that.
You do not necessarily have more money working for by not doing a Roth conversion, because that money is not just yours. You are in a partnership with the IRS and every year they get to vote on what percentage of your profits they get to keep.
It all comes down to what tax rates will be in the future when you are taking money out of your investments, compared to where they are today. If you believe that tax rates are going to be higher in the future than they are today, then it makes sense to do a Roth conversion.
Could the Federal Government Take Away Your Roth or LIRP? with David McKnight
David prefers to be a clear-eyed realist and face things head on, mincing words about the fiscal situation of the United States would be a disservice to everyone. One of the big things that people have asked about after the previous episode is whether shifting all their money to tax-free will do anything for them. If the situation is so bad, what’s to stop the government from taking these programs away?
There are two traditional approaches to retirement and taxation, namely, the government is going to tax you either on the seed or the harvest. That is to say, either preretirement or postretirement. In order for the government to tax your Roth IRA, they would have to completely abandon the very paradigm they have forced you to submit to, which would likely lead to chaos in the streets.
When you add up the cumulative Roth IRA’s and 401(k)’s of Americans, it adds up to about $800 billion. When it’s compared to the cumulative amount in traditional IRA’s and 401(k)’s, approximately $23 trillion, it doesn’t make much sense for the government to violate a principle they’ve established because the total wouldn’t have much of an impact on their fiscal situation.
It would be much easier for the IRS to do what they’ve done in the past, namely to raise taxes on the pot of money that is owned by the people they are in a business partnership with. It’s legal, they’ve done it before, and as money grows in shorter and shorter supply they become more likely to do it again.
If you have a Roth IRA, they will likely prevent you from contributing to it at some point in the future, but the risk of taxing these accounts would probably be too great to justify the action.
L.I.R.P.’s will probably go away at some point in the future. As the US approaches the point of no return, the federal government will be looking at all options to increase revenue and they’ve already looked at removing the L.I.R.P. in the past.
George W. Bush sought to level the tax playing field in the early 2000’s which reveals a key principle; specifically, whenever they change the rules whoever has the bucket gets grandfathered in. If history serves as a model, if you already have an L.I.R.P., you will get to keep it and continue contributing.
This creates even more urgency for people who don’t yet have an L.I.R.P. to get one and get it secured soon. The greatest tax benefit in the US tax code is the tax benefit for life insurance. If the country is going broke, as we are, they will not allow these benefits to exist in perpetuity.
If the past is a prologue, we can look to history and be confident that we can continue with these programs and keep contributing to them for the rest of our lives.
Don’t worry too much but do face the situation head on. There are places in our country that you can safeguard your money against the inevitable and dramatic rise of tax rates in the future.
What You Need to Know About Tax Changes in 2020 with David McKnight
The new year brings important changes to the IRS tax code along with various thresholds that we have to know about when it comes to Power of Zero planning. We have to be keenly aware of these thresholds because they can end up being landmines if we’re not doing things correctly.
The new income threshold for the Roth IRA is $124,000 to $139,000 for a single person and $196,000 to $206,000 for a married couple. The good thing about the Roth IRA is you have until April 15th of the following year to figure out how much you are going to contribute.
The Roth conversion is a little more difficult. You have to make the decision before you have all the information prior to Dec 31 and you can’t change it once it’s been done.
401(k)’s have changed quite a bit as well, with increased limits on contributions for both people younger and older than age 50. This applies to Roth 401(k)’s as well which is good because you should take advantage of anything with the word Roth in it. We’re marching into a financial apocalypse so it’s very important to take advantage of as many of these diversified tax-free streams of income as possible.
The standard deduction has also increased, but in 2026 we will be reverting back to the tax code of 2017, so the net result is likely to be pretty much the same.
Required minimum distributions have been pushed back by two years. This won’t really impact people who need the money as they would withdraw it either way. This can be advantageous for people who don’t need the money because they won’t be forced to realize the income in their IRA’s. However, they may be hit with higher tax rates as taxes increase in the future.
The stretch IRA has been abolished. This means that your non-spouse beneficiaries will have to spend down your IRA’s and 401(k)’s in the ten years following your death. This is another reason to move your money to tax-free so that your inheritors won’t have to pay some of the highest tax rates at the apex of their earning years.
You can now contribute to your IRA after age 70 and a half which you couldn’t before.
Gift and estate tax exemption is now at $11.8 million per individual but there is a chance that these changes may not last if a different administration takes the Senate, Congress, and White House.
These changes are largely good for people looking to implement the Power of Zero strategy but there are some questions for the IRS that can be very revealing. The fact that they haven’t adjusted the contribution limits of the Roth IRA to keep up with inflation should tell you that Roth IRA’s are good things.
The ideal approach to tax-free retirement is to 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 bucket. They are all pieces of the Power of Zero puzzle.
Is Our Country's Fiscal Condition Past the Point of No Return? with David McKnight
For a grim depiction, check out this article The Mathematical Certainty of U.S. Government Default by Ptolemy3 about the future of the US government’s debt situation.
The US government reached the tipping point at least fifteen years ago where the only way out will be default. People who calculate debt for the US federal always do it incorrectly. The proper way to do it is to figure out the net present value of everything that we’ve promised over the years minus what we can actually afford to deliver.
The US government currently only projects these numbers out for 75 years, if they went out beyond that timeline the situation get much worse.
The fiscal gap is growing. The expenses are going up dramatically and will continue to do so for years while the cash flow remains relatively static based on current tax rates.
The author begins by looking at US government positive cash flow. Any prediction that economic growth will rise dramatically over time is based on religious belief. There is no data that suggests that economic growth will increase more than 2% in our lifetimes short of an AI revolution.
Some people are suggesting that we’ve hit a maturity on economic growth and are actually approaching a decline. The basic standard programs are not likely to change; once a government program gets established it’s incredibly hard to get rid of it.
Looking at the current assets and liabilities and estimating what the future cash flows will be over the next 75 years paints a pretty dark picture. When broken down, the net present value of the future obligations for social insurance programs alone is $49 trillion.
Core operations of the government are actually running in a surplus, but the situation gets really ugly when you get to the interest payments on the debt. The current payment is around $300 billion but interest rates are projected to increase to an average of 5.1% over time. This means we would have to have $110 trillion dollars in the bank account today earning Treasury rates to be able to deliver on just the debt.
The Terminal Value, the number we would need to have in the 75th year to be able to bankroll the expenses of the federal government in perpetuity, is an astonishing $1.6 quadrillion.
When you add all the numbers up the net present value of all our future obligations is around $239 trillion. To put that into perspective, our fiscal gap represents almost 70% of all the money in the world.
We are deficit spending, basically using debt to pay our bills. As the debt increases, there will be a point where it starts to snowball and we won’t be able to afford the interest on the debt no matter how much we cut back on other programs, and we’ve already passed the point of no return on that number.
When interest rates go up, the costs of servicing the debt will triple. If the government defaults on the debt it would likely plunge the world into a depression.
The author considers what would happen if we continued on the current path. By 2038, the US government will be running an annual deficit of $3.3 trillion which will last for decades in the future. We would most likely default at this point since waiting until 2058 or later would only make the future default more devastating.
Gokhale and Smetters published a paper titled “Is the United States Bankrupt?” It describes the solution to the problem that would involve an immediate and permanent doubling of personal and corporate income taxes, and/or an immediate and permanent two-thirds cut of all social security and Medicare benefits.
The author comes to very similar conclusions. When using the government’s numbers from their own financial reports, he ran into problems trying to reconcile their math. It looks like the government is deliberately trying to hide large numbers from the calculations including government employee benefits and Medicaid.
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