The Power of Zero – How to Get to the 0% Tax Bracket and Transform Your Retirement by David McKnight
In the Power of Zero book by David McKnight, the author lays out a well-devised strategy that will accumulate sufficient wealth for retirement and enable a tax-free income stream.
Mr. McKnight uses a “three-bucket” strategy for wealth accumulation that should be utilized by everyone and makes a terrific case for why each bucket is necessary.
If you are concerned about your tax-liability during your retirement years and are unsure if your current retirement planning efforts will enable you to realize a retirement lifestyle that you’ve been planning for, this book lays out an easy-to-understand retirement strategy that will get you there.
We hope you’ll enjoy The Power of Zero summary.
Chapter 1 – A Gathering Storm
Table of Contents
In the first chapter of The Power of Zero book, Mr. McKnight comes out of the gate with a solid explanation for why the reader should completely consume the book by explaining the threat of income taxes on investment products you may be currently using.
He goes into an in-depth discussion that social security was never designed to provide retirement income but only to help those workers who might live to long. When you consider that Social Security, Medicare, Medicaid, and the interest on the National Debt will consume 92% of the government’s revenue in 2020, it’s shocking to consider how taxes will have to be increased to keep these programs solvent.
In The Power of Zero book, there is an obvious and reasonable argument for the need of protecting one’s retirement from Uncle Sam using the strategies laid out chapter-by-chapter. The strategy is implemented by using three specific buckets of money along with easy-to-understand instructions about how much money each bucket must contain and why.
Chapter 2 – The Taxable Bucket
The taxable bucket contains funds that should be available for the unexpected costs of life events that typically happen to everyone. The recommended amount to accumulate is six times your monthly income; no more, no less.
The most important thing about the taxable bucket is liquidity. This means that CDs, Mutual Funds, stocks, and bonds would be used and since you’ll be paying income tax on the annual growth, it makes sense not to have more money in this bucket than what is necessary.
Mr. McKnight goes into the pros and cons of the taxable bucket and how the cons can be restricted by having only six months of liquid income available in this bucket.
If anything stands out in the Power of Zero book, it is the reasoning that the author lays out for the reader and the manner in which he lays out his argument for the tax-free retirement plan.
Chapter 3 – The Tax-Deferred Bucket
The tax-deferred bucket is what most of us are familiar with. This bucket is for tax-deferred investments like a 401(k) or IRA which most employees favor because they can “set it and forget it” and make easy contributions that are tax deductible from the get-go. And even better, if your employer matches a portion of your contribution, you’ll get free money on top of your money.
McKnight does go on to explain how your tax-deferred bucket could have unintended consequences if the bucket contains too much money. Throughout this chapter, McKnight discusses the pros and cons of tax-deferred accounts and how to stay away from the “your taxes will be lower at retirement” assumption.
Most employees don’t consider what their tax liability could be when they begin taking distributions from these accounts because the IRS will be in charge when you take those distributions, not you. Here is where McKnight pulls the curtain back on the reality of your tax liability at retirement and readers using the David McKnight power of zero strategies can learn to avoid much of this tax liability.
He goes on to explain that even if you may have a lower tax rate, you’ll likely no longer have the deductions that were available while you were paying a mortgage and raising kids.
Mr. McKnight goes on to close out the chapter by explaining what he calls “the catch 22 of tax-deferred retirement plans and goes into specifics about how provisional income can have a disastrous effect on your Social Security benefits. And remember, it’s all about the math. The good news is that Mr. McKnight explains the “math” so that the reader will easily understand something that would ordinarily be difficult.
The last paragraph in the chapter contains the assurance that every reader will look for. “In summary, the tax-deferred bucket has a number of different pitfalls that can hinder your efforts to reach the 0% tax bracket. When used in the right amounts and under the right circumstances, however, it transforms into the perfect stream of tax-free income and makes a valuable contribution to your 0% tax strategy in retirement.”
Chapter 4 – The Tax-Free Bucket
Certainly, the tax-free bucket becomes the emphasis of the book. Most people are already using the first two buckets and only need to change the manner in which they are using them. Using the David McKnight power of zero wealth accumulation strategy helps avoid the unintended consequences that were discussed in earlier chapters.
Also referred to as tax-advantaged or tax-preferred, this third bucket is where the rubber meets the road. McKnight points out early on in this chapter that there are many kinds of investment products out there that are masqueraded as tax-free, but really are not unless they meet two qualifiers:
- The product or method must be truly tax-free. This means all taxes, not just federal tax. McKnight points to municipal bonds here that are free from federal tax but not state taxes and thus, should not be considered tax-free for the purpose of the tax-free bucket.
- Any money that is distributed from a tax-free investment product cannot be counted as provisional income and thus trigger a tax on Social Security benefits. Once again, the interest on municipal bonds does count as provisional income.
After Mr. McKnight spends some time talking about investment products that are tax-free impersonators, he spends quite a bit of time discussing investments that do qualify for your tax-free third bucket of money. Here are the investment products that he recommends with some backup as to why he recommends them to take advantage of the power of zero percent:
Here, McKnight lists the Roth Individual Retirement Account as possibly his favorite tax-free investment method because it meets the two criteria we listed above.
- All distributions taken at age 59 ½ or later are immune to federal taxes, state taxes, and capital gains taxes.
- Additionally, distributions from your Roth IRA will not count as provisional income and, therefore, will not cause unintended taxation of Social Security benefits.
- Although your contributions to the Roth IRA are not tax-deductible, your money in a Roth IRA will grow tax-free and not subject to any taxes upon distribution (as long as you are 59 ½ or older).
Although the Roth IRA qualifies for your tax-free bucket, it’s important to note the drawbacks. Just remember, anytime the IRS lets you off the tax hook, they’ll always come back with constraints like contribution limits and limits on the investor’s income. There also liquidity constraints placed on the growth of the money in your account if you access it prior to age 59 ½.
Here is where Mr. McKnight’s advice is so valuable: “In what circumstances should you contribute to a Roth IRA? The answer depends on whether or not you will be in a higher or lower tax bracket when you take the money out in retirement. That’s it. End of story.”
Here, Mr. McKnight goes on to lay out examples of how the math will work under various circumstances which makes it easier to understand if the Roth IRA is the best decision for you. He also spends the time and space in his book discussing if converting from a traditional IRA to a Roth IRA will allow you to shift investment dollars into the tax-free bucket. This process, although relatively simple, should be done with diligent care to avoid unintended tax liability.
Chapter 5 – The LIRP
Chapter five is dedicated to investors who have repositioned their assets into traditional tax-free investment products but because of IRS limits and constraints, it’s unlikely that you’ll get to the coveted 0% tax bracket. Now it’s time to think out-of-the-box and consider what is known as a Life Insurance Retirement Plan or LIRP. McKnight points out that where traditional tax-free investment products come up short, the LIRP is not subject to the same limitations.
It’s important here that the reader focuses on the investment component of the life insurance policy and not the death benefit. In fact, an experienced insurance professional will typically recommend that the investor select the lowest death benefit possible so the premium dollars paid will go toward growth rather than a death benefit. Your LIRP, when funded correctly, is immune to those IRS “gotcha” rules that hamper the purpose of your investment:
- Distributions from a LIRP are truly tax-free
- Distributions from a LIRP do not count as provisional income and therefore cannot trigger taxation of Social Security benefits.
- There are no limits on contributions to a LIRP as there are with traditional investment products like the Roth IRA.
- A LIRP has no limits on income. Here, Mr. McKnight points out that about 85% of Fortune 500 CEOs use the LIRP as their primary retirement planning tool. Where a Roth IRA can fall short, the LIRP is the best alternative.
- History shows us that a LIRP is a safe harbor from tax-hungry legislators.
Although there are multiple accumulation strategies for your LIRP, using Indexed Universal Life Insurance offers a method of investing in the stock market without actually being in the stock market. This means the policyholder can take advantage of higher returns than traditional investment products offer and not be exposed to losses. This is our opinion, not a statement by David McKnight, but we’re sure he’ll agree that an IUL policy can expose the power of zero percent tax liability at retirement.
Balance Your Buckets
In the latter portion of chapter 5, Mr. McKnight discusses the ideal balance for your three investment buckets. If you understand and agree with the investment strategy provided so far, it will be critical for you to understand your investment bucket balance:
- The Taxable Bucket – This bucket should contain six months of earnings to protect from and provide for financial life events. If you have met this threshold and are still contributing for financial emergencies, stop and shift those contributions to your tax-free bucket.
- The Tax-Deferred Bucket – The balance in your tax-deferred bucket should not exceed what your RMDs at age 70 ½ will be equal or less than your standard deduction for that year. If you are contributing to a 401(k), your contributions should not exceed what your employer will match. Any amount more than this should be redirected to the tax-free bucket.
- The Tax-Free Bucket – Since this bucket will deliver a tax-free stream of income at retirement, it makes sense to invest as much as possible into this bucket so that your retirement plan will come to fruition.
The Power of Zero Summary
The Power of Zero Summary: Once you’ve come to understand the detrimental effect taxes will have on your retirement, it’s an easy decision to use David McKnight’s book to guide you down the proper path for retirement planning. With the debt in the U.S. over $22 trillion and knowing that only increased revenue (more taxes) and reducing expenses can chip away at this debt, it’s certainly not a leap to expect higher taxes after the new tax cuts are scheduled to sunset. There is time to prepare if you make the important decisions today.
The result of our Power of Zero review is that the book should be a must-read for anyone who wants to prepare for the inevitable tax increases on the horizon and strategically protect their accumulated wealth from the impact of taxation.
In 2019 David McKnight has also published The Volatility Shield and continues the zero tax bracket conquest.
Frequently asked Questions
Why is an IUL policy better than a 401(k) or IRA?
Although having a 401(k) is great if your employer is matching your investment dollar for dollar, the employer will have a limit on the amount that will be matched. Once you reach that limit, your wealth accumulation is substantially impacted. Also, if you are investing in an IRA, you’re subject to constraints placed on the account by the IRS. The IUL has no constraints like early withdrawal penalties and required minimum distributions. Click here to learn more and find out why the IUL is the better choice.
Does Dave Ramsey believe an IUL policy is a good choice?
If you’ve listened to Dave Ramsey’s shows or read any of his material, you’ll find out quickly that Mr. Ramsey does not consider cash value life insurance an appropriate retirement planning vehicle. Dave Ramsey believes that Term insurance is the only life insurance product worth buying.
Are the withdrawals from an IUL policy tax-free?
When you take funds out of your IUL using policy loans rather than a standard withdrawal, the loans are not considered income and therefore are exempt from income tax. You will have to pay some interest on your policy loan but it will be far less than if you had to pay taxes. This is why David McKnight refers to borrowing money from your self, the Power of Zero.
What is the power of zero?
When it comes to retirement planning, your accumulated wealth can be substantially impacted by the taxes on your withdrawals. The power of zero is a strategy that allows an individual to accumulate wealth over their lifetime that can be taken as an income stream using loans that are tax-exempt.