There's a four letter word that's being used with surprising frequency in our nation's capital these days. It's MATH. Seems our government has promised way more than it can afford to deliver for so-called entitlement programs like Social Security, Medicare and Medicaid. Throw in another $17 trillion of debt and we've got the makings of a real financial crisis on our hands. In short, the numbers on our nation's financial ledger just aren't adding up. Former Comptroller General of the Federal Government David M. Walker has even suggested that tax rates have to double to keep our country solvent. The Congressional Budget Office recently reported that if tax rates don't rise dramatically by 2023, we start defaulting on our debt. If this doesn't seem like a big deal, ask Russia what happened when they defaulted on their debt.
So, if you are planning to draw on traditional tax-deferred retirement plans after the year 2023, what should you make of all this? The fact is, when you invest in 401(k)s or IRA's, you're entering into a business partnership with the IRS. Unless you can accurately predict what tax rates are going to be in the year you take those dollars out, you have no idea how much of that money is really yours. And, it's pretty hard to plan for retirement if you don't know what share of these government plans you can actually take home and spend.
Amid all the grim numbers and statistics there is a silver lining. Current tax rates haven't been this low in 80 years, so the cost of repositioning these highly taxable accounts into tax-free accounts has never been more inexpensive. In my experience, however, the process of transitioning these taxable assets to tax-free assets cannot be undertaken haphazardly. The key here is to shift assets 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 you won't be able to stomach.
David McKnight's recently released book The Power of Zero: How to Get to the 0% Tax Bracket and Transform Your Retirement tackles all of these issues and more. McKnight makes the case that if tax rates double, the safest tax bracket is zero. Why? Because if tax rates double, two times zero is still zero. He defines a true tax-free investment as first, one that is free from federal, state and capital gains tax and second, one whose distributions don't cause your Social Security benefits to be taxed. This last one is especially germane to a retiring generation of baby boomers who will increasingly rely on Social Security as a major cog in their retirement wheel.
The most salient point in McKnight's book comes back to the same four letter word of which I spoke at the beginning of this article: MATH. If tax rates double, and you're at the zero percent tax bracket, what's two times zero? It's still zero. The only way to truly insulate your hard earned retirement dollars from the threat of higher taxes is to reposition them to tax-free alternatives.
McKnight defines "true" tax-free investments as Roth IRA's, Roth Conversions, Roth 401(k)'s and even a properly structured life insurance contract, commonly referred to as a "LIRP," or Life Insurance Retirement Plan. The key is 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 zero percent tax bracket in retirement.
It's hard to make the case that tax rates won't rise, even dramatically, within the next 10 to 15 years. What does all this mean? Mathematically, if taxes will be higher in the future than they are today, then failing to take advantage of tax rates while they're on sale will mean less after-tax cash flow at retirement. So, when considering our country's fiscal condition and its mounting debt loans, make sure you put together a retirement roadmap that cuts the IRS out of the equation and puts math on your side. Doing so would permanently disinherit the IRS from your financial plans, and allow you to enjoy a totally tax-free retirement.
As a Best Selling Author and Financial Strategist, I get it. I've walked through the same fire that most of us are walking through right now -- the disappearing nest egg, the investment returns that never happen and the house with the white picket fence that's worth less now than it was when we bought it.
Through experience, education, and a lot of hard work, I have survived the American Dream turned financial nightmare. I have discovered that most of us are following nine specific financial myths I call the "Mom and Dad Plan," which are inadvisable, yet staple, beliefs that have us on a collision course with financial disaster. For access to my best-selling book and other financial products to help you avoid the collision course with financial disaster, visit me on the web at www.ikeikokwu.com.
