The power of zero FAQ

We know that tax rates are likely to remain low until 2026 at which point they’ll revert back to what they were in 2017. But eventually the math challenges facing our country are going to catch up with us. As we get to 2028, 2030 and beyond, the national debt will be so high that the cost of servicing it will consume the entire federal budget. So, that’s really the day of reckoning for our country. At that point the federal government will be constrained to raise taxes in order to pay for non-discretionary expenses—things it’s required to pay for by law.

I love it when things make sense conceptually, but I love it even more when things make sense mathematically. The whole goal of the Before and After Comparison is to make the case mathematically that by adopting a zero tax approach to retirement you’re going to be better off than you otherwise would be. First, we run a projection that shows how long your money would last should tax rates stay the same and you keep on your present course. In the second projection, we show how much sooner you’d run out of money if taxes were to double. We then run a final projection that shows how much longer your money would last if you adopted a zero-tax approach to retirement. If your assets last five to seven years longer and you spend an extra million and a half dollars along the way, it’s probably worth looking into. The Before and After Comparison makes the case mathematically that what we’re recommending is going to push you further ahead than where you would otherwise be.

You have to get the shifting done quickly enough that you get all the heavy lifting done before tax rates go up for good but slowly enough that you don’t rise into a tax bracket that gives you heartburn. The perfect amount of money to shift is what I call the magic number. This number represents the perfect amount of money that should be shifted each and every year between now and when tax rates are likely to go up for good.

There are a couple of alternatives when it comes to mitigating long-term care risk. The first alternative is the one that gives people the most heartburn: traditional long-term care insurance. With this approach you pay for something that you hope you never have to use and, should die peacefully in your sleep thirty years from now never having needed it, someone else receives your benefit. I advocate for an approach known as the life insurance retirement plan (LIRP). It provides a death benefit that doubles as long-term care and, should you die peacefully in your sleep thirty years from now never having needed it, someone still receives that death benefit, probably your children or grandchildren. So, there isn’t that sensation of having paid for something that you hope you never have to use.

There are a couple things that we can do. The first is to get the debt under control. The debt is being driven primarily by Social Security and Medicare, our country’s two largest unfunded obligations. Social Security is a relatively easy fix–you just have to push the retirement age back to 70 for people in my generation (Generation X). Furthermore, we have to raise substantially more revenue because Medicare is five times more expensive than Social Security.

We know that at the end of 2017 they passed the Tax Cut and Jobs Act which I refer to in The Power of Zero as “The Tax Sale of a Lifetime.” Here’s the rub: that tax sale has an expiration date of January 1st, 2026. That means that every year between now and 2026 represents a little, mini window of opportunity within which to take advantage of historically low tax rates. Every year that goes by where you fail to take advantage of historically low tax rates to get your tax-deferred assets repositioned to tax-free, means you could be forced to pay taxes at a point beyond 2026 at the highest rates you’re likely to see in your lifetime.

Over the last twenty-five years I’ve helped put thousands of Americans on the road to the zero percent tax bracket. Along the way I’ve noticed that it’s nearly impossible to get to the zero percent tax bracket by utilizing just one stream of tax-free income. You can’t get there, for example, by simply contributing to a Roth IRA. You can’t get there by simply owning an LIRP. To get to the zero percent tax bracket typically requires 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 zero percent tax bracket. We want to take advantage of every nook and cranny in the IRS tax code. Every stream of tax-free income they allow has a different, unique attribute and when you use these streams of tax-free income in concert with each other it makes for a comprehensive, balanced approach to tax free retirement plan.

In 2009 I was giving a presentation in Fond du Lac, Wisconsin, two days before midterm elections. When I was done with my presentation everyone came up to me and asked who they should vote for. I told them it doesn’t matter who you vote for because whoever gets elected is going to inherit a math problem, the solution to which involves either doubling taxes, reducing spending by half, or some combination of the two.

Let me answer this question with a story. Not long ago, a lady came up to me at the end of my presentation and said, “Hey Dave, thanks a lot! Now I’m in a really bad mood!” I said, “Why are you in such a bad mood?” She said, “Because I have all my money sitting in the tax-deferred bucket!” So, I said, “Let me see if I understand this correctly. You contributed money to your IRA at a period in time when tax rates were dramatically higher than they are today and you got a deduction at those higher rates for doing so. You now have a four-year period of time during which to take advantage of historically low tax rates so you can get all those assets repositioned to tax-free so that by the time tax rates double over time you’ve done all the heavy lifting and you can then take those assets out tax-free? Is that why you’re in such a bad mood?” She then said, “Well gosh, Dave, I never really thought about it that way!” So, the real question is how is this story going to end for most Americans? I would submit that so long as they take advantage of this period of historically low tax rates that they get to determine how much of their hard-earned retirement savings that they get to spend.

The reality is that the average expenses over time are not any higher than what you might expect in a traditional 401(k) or a brokerage account. With the LIRP, the expenses are a little bit higher in the early years but much lower in the later years. When you average them out over the life of the program, however, it’s going to cost you about one and a half percent of your bucket per year. So, whatever road you take in life, somebody is going to be making one and a half percent. The question is: What are you getting in exchange for that one and a half percent? With the LIRP you’re getting tax-free growth and a death benefit that doubles his long-term care.

Well, the first thing I say is, “Don’t panic!” Twenty-five to thirty percent of the people who walk into my office every day have pensions. I always start off by saying, “Look, let’s worry about the things we can control, and let’s not worry about the things that we can’t.” The reality is that once you draw your pension, it will be construed as provisional income by the IRS and will likely cause your Social Security to be taxed. So, this isn’t something you have control over. However, you do have control over the taxation of all your other assets. That means that you can still take advantage of historically low tax rates to get your IRAs and your 401Ks systematically shifted to the tax-free bucket so that by the time you reach retirement you can take those assets out tax-free.

We begin by gathering our clients’ information and situating their assets within the three buckets: taxable, tax-deferred and tax-free. We want them to visualize their financial world through the Power of Zero lens. We want them to recognize that they may have too much money in their taxable or tax-deferred buckets. Once they do, they’ll feel the urgency to systematically shift any surplus assets to tax-free. We then lay out a Before and After Comparison which consists of three projections. The first one says: if you keep on doing what you’re doing, and don’t change a thing, how long will your money last? We then run a second projection that says: if you keep on doing what you’re doing and tax rates double, how much sooner will your money run out of money? (Plot Spoiler: it’s about 10 to 12 years faster). We’ll then run a final comparison that says: if you do everything that we recommend that you do, and we get you at or near the zero percent tax bracket in retirement, how much longer will your money last? And if your money lasts five to seven years longer and you spend an extra million and a half dollars along the way, it’s probably worth looking into.

In chapter six of my book The Power of Zero I talk about how tax rates went on sale in 2017 and they’re now as low as we’re likely to see in our lifetime. We now have a narrow window of time within which to take advantage of these historically low rates. On January 1st, 2026, those tax rates are going to revert back to what they were in 2017. Most experts agree that by the time we get to 2028, 2030 and beyond, tax rates are likely to be dramatically higher than they are today. So we need look at the lead-up to 2026 as a little window of opportunity during which to take advantage of historically low tax rates.

The life insurance retirement plan (LIRP) is a bucket of money that gets treated differently for tax purposes than traditional retirement vehicles. You put money into this bucket and, as your money grows, your bucket begins to fill. Only, the IRS says that the growth on the money in this bucket is going to be treated under a different section of the IRS tax code than anything than traditional retirement accounts. What does that section of the IRS tax code say? It says that as your money grows you receive no 1099s, so no tax as your money grows. When you take the money out, if you take it out the right way, it’s not going to show up as reportable income on your tax return. That means no taxation and no provisional income which could prevent your Social Security from being taxed. Unlike the Roth IRA, there are no contribution limits. And, unlike the Roth IRA there are no income limitations. And finally, if history serves as a model, there may be no legislative risk. This means that if the government were to ever change the rules on this bucket, whoever has the bucket would likely be able to keep it and continue to put money into it under the old rules for the rest of their lives. That’s what’s traditionally known as a grandfather clause.

Back in 2009 the former Comptroller General the U.S. government, David Walker, made a prediction: tax rates will have to double or we could go broke as a nation. Today, we’re marching into a future where nearly every economist agrees that tax rates within the next ten years are likely to be much higher than they are today. That’s why I wrote The Power of Zero, which highlights the importance of getting to the zero percent tax bracket in retirement. Why? Because if tax rates double, two times zero is still zero.

Most Americans see the handwriting on the wall and recognize that the government is spending money we don’t have with reckless abandon They also recognize that the only way to finance our country’s mounting debt is to dramatically raise taxes. Unfortunately, the thirty trillion dollars they have in their cumulative retirement accounts is a likely target for a revenue-hungry IRS. If the federal government decides to dramatically increase tax rates, how much of their hard-earned retirement savings are they going to be able to keep?

The federal government has promised way more than it can afford to pay in the form of Social Security, Medicare, Medicaid, and interest on the national debt. At current tax rates, the national debt will continue to grow and compound by about a trillion dollars per year between now and 2030. Even higher thereafter. We’ll eventually get to the point where simply servicing the interest on all the national debt (renting the money that we’ve already spent), is going to consume the entire federal budget. We won’t have anything left for welfare services, food stamps or even the basic costs of running the federal government. At that point, the federal government will be constrained to raise taxes to pay for all this non-discretionary spending—things they’re required to pay for by law. So, Americans are going to have to come to grips with the reality that tax rates within the next ten years are likely to be dramatically higher than they are today.