My current nightstand reading list. The Power of Zero is a quick read, and I finished it in just a few nights. In comparison, the writings of Butchart and Steck are much more cryptic.
Huh, what? A book review on this website, about personal finance?
Yep, this is a first, and a bit of an experiment. I know I am venturing outside my area of expertise, but this review is at least consistent with the general objective of this website, the sharing of useful information.
The Power of Zero: How to Get to the 0% Tax Bracket and Transform Your Retirement, by David McKnight, was recommended to me last month by a visiting friend who recently started a business. It’s available in paperback, ebook, and audiobook from Amazon.com. If you don’t get it for free through KindleUnlimited or an Audible subscription, it will still probably pay for itself many times over by reducing your tax liability in retirement.
My hope in reading The Power of Zero was to learn about tax-advantaged retirement vehicles besides the popular ROTH IRA and 401(k), both of which Amanda and I already have and contribute to. My friend had specifically mentioned LIRP’s, which was a new one. What else might this book teach me?
McKnight’s advice is fairly simple: put as much of your retirement savings as possible into tax-free accounts (e.g. ROTH IRA), and use very deliberately accounts that are tax-deferred (e.g. 401(k)) and taxable (CD’s). His underlying assumption is that tax rates will rise in the future, which makes it financially advantageous to pay tax liabilities now, not later. Even if you don’t buy into an oncoming fiscal train wreck, which he predicts in his free sample chapter, you should at least agree that future tax rates are at risk, whereas today’s rates are certain.
The Power of Zero is a quick read. It’s not long; the math examples are uncomplicated; and the writing style is layman-friendly. I suspect that through his investment seminars, which he has since franchised, McKnight developed an effective communication style with his target audience, similar to the benefit I experienced by guiding trips.
To reach the 0% tax bracket in retirement, unfortunately there are few methods available. ROTH IRA’s are the best game in town. Thanks, dad, for creating accounts for me and my sisters in 1998, the first year you could. Another option — and new to me — are LIRP’s, or Life Insurance Retirement Plans, which receive a similar tax treatment to ROTH’s but which offer more flexibility. For example, LIRP’s have no income or contribution limits, and funds can be used to defray long-term care costs.
In addition to LIRP’s, I thought The Power of Zero was useful in offering contribution strategies for taxable and tax-deferred accounts. For example: How much should I keep in my taxable brokerage account? How much — or to what total — should I contribute each year to my self-employment 401(k)? If Amanda’s employer does not match her 401(k) contribution, should she still contribute or should we look at other options?
It may seem premature for a thirty-four year-old to be thinking about his golden years. Hardly. By saving now, and investing wisely in tax-advantaged accounts, we can have far greater influence over our finances in retirement than if we wait. I only regret not reading The Power of Zero earlier.
Disclosure: I purchased The Power of Zero with personal funds. This post contains affiliate links.
It is in no way premature to be thinking about retirement income. Everyone entering the workforce should because the money that you put back when you are young will likely be much more important than the money you put back near retirement. It’s good that you have these tax advantaged vehicles and you should make the best use of them, but you need a plan and you need to stick to it. Many people cash out their 401(k) when they leave an employer and they don’t realize that they have wasted everything that they put in. If you have access to a Roth 401(k), so much the better.
Good advice. Sticking to the plan seems to be the hard part for many. For a person like myself who dislikes uncertainty, it is a challenge to invest in a market with an unknown future, even though over any 25-year period, when I will be 59) the market returns better gains than anything else historically. I have slowly bought into this, and now dump money into our accounts and buy index funds whenever I have excess cash. In 2040, that investment will be worth more than it is today.
Without prejudice to the information on retirement vehicles in the book, I would not pin all your hopes on the idea that these methods will avoid taxes in the future. If the author is correct that the federal government will need to dramatically increase tax rates, the possibility exists that the government will change the rules, and decide to tax the capital gains in your ROTH IRA. After all, this is what happens to gains taken from an ordinary brokerage account, even though your investments were purchased with after-tax dollars. If the government really needs the money, it will go where the money is.
Yep, I’m aware of that possibility. However, if I were to assess the relative risk of the investment tax rates, it would seem that ROTH IRA’s are at the least risk. We’ve seen changes recently in the cap gains tax — 5 percent here, 5 percent there isn’t that hard. But to push the tax rate off zero, that requires a lot of political will. Not saying it can’t or won’t happen, but it seems like it will be one of the last places they go for revenue.
I hope you are correct for the sake of those who can and are taking advantage of the ROTH IRA. But it would only be moving the cap gains rate off of zero for those who have such accounts; the rest of us are already paying on cap gains. How much political will it would take depends on how many (mostly younger people) start using them, and how old they are (and, thus, more likely to vote) when the government decides it is hurtin’ time.
There are lots of good places on the internet to get this type of information, some of them give the benefit of debate of any particular strategy.
Specific case studies by tax optimizer
http://www.gocurrycracker.com/never-pay-taxes-again/
http://rootofgood.com/make-six-figure-income-pay-no-tax/
Tax Avoidance Section
http://www.madfientist.com/archives/
Good summary article of US tax options
http://forum.mrmoneymustache.com/taxes/the-mustache-tax-guide-(u-s-version)/
Hi Andrew,
Perhaps you have visited the website of this guy but, if not, I highly recommend it. His methods work- they are based on intelligent frugality, something that I have practiced long before Peter came along and codified it. I similarly “retired” at an early age based on the salary of a professional office worker.
The New Yorker recently profiled Peter and his approach:
http://www.newyorker.com/magazine/2016/02/29/mr-money-mustache-the-frugal-guru
b/t/w prediction of the future economy seems to be principally about whether one has faith (and I do mean faith) in US capitalism- if you do then your index funds will be well positioned, if not, well there will likely not be any safe heaven…..
Another thing to think about is a health care savings account. If you pay for your own health care insurance, this is a tax advantaged way to save some money. HSAs are not popular with banks, so it takes some investigation to find a place to open one. Just like IRAs, the money needs to be invested in order to have any kind of return, but it provides a way to pay for medical expenses with pretax money.
Good tip, thanks.
Since Amanda works for CU, which has a relatively generous health care benefit, we are thankfully in pretty good shape in this front right now. But if she were to leave then we would definitely be looking for options.
If you have employee health care coverage, you probably also have access to a flexible spending account. An FSA is similar to a HSA, but the contribution amount must be spent during the current year (That may have changed since I had one). The HSA can be rolled over and used in subsequent years. If the HSA is not used for medical expenses, it can be treated like an IRA and the money withdrawn is treated like ordinary income. I’d check on the contribution limits, because you might be able to have both.
Andrew —
A little late, but just ran across this blog post. The advice I would offer is to be wary of LIRPs, and to be wary of any investment product that’s bundled with life insurance or sold by insurance companies. Yes, I know you can read the book and they’ll have some kind of explanation for everything, but simplicity is important. There’s a reason investment-bundled insurance products are sold by agents (who get fees): almost nobody would buy them otherwise; they need to be “sold”, they need “sales pitches” (the book provided a pretty good oone). If you ask to have the underlying mechanisms of how things work, what fees are taken out, and how fees are calculated, it’s often very difficult to get clear answers. It’s not like these products or always bad for everybody. But for most people it’s much better to keep things simple (which managing your own investments in IRAs or 401k is) and flexible.
I read a tiny bit of the book — I wouldn’t buy it, but it was available for free as part of Kindle unlimited. A couple things jump out at me as red flags right away. First, in the LIRP chapter McKnight acknowledges that some have criticized LIRPs as having high fees. He responds to this criticism by claming that the average costs of a 401(k) plan is about 1.5% per year, and fees for LIRPs are similar. He may be right about average for 401(k) plans, but if he is it’s because a lot of 401(k) plans have high fees. In any case, fees for 401(k) depend on the investments you have in the 401(k). Many 401(k)’s may have limited choice of bad high-fee funds. However, many don’t, you have to check. A growing number of 401k’s will have lower fee funds available, typically index funds. Fees for those can range from 0.10% to 0.5% per year. Also, if you leave you can roll assets over into an IRA where you’ll have full flexibility to purchase whatever low-fee funds you want. So, main thing is that it’s ingenuous at best to suggest that the alternative to LIRPs has fees as high as LIRPs. You should focus on low fee investing. Holding an investment product that sucks an average of 1.5% per annum out of your assets for 10, 20, 30 years or more is crazy. And from what McKnight describes fees are even higher in the early years, which is worse for the investor.
Second thing that jumps out at me is touting LIRPs as flexible tool to pay for long term care. Long term care in most cases will be a deductible expense. That is, you will deduct those expenses from your income whenever they happen. The long term care expenses are already tax friendly.
Third thing is regarding “flexibility” of LIRPs. Most important “flexibility” item I want is ability to get out of an investment if I decide I don’t like it, and LIRPs are terrible here. Part of the safety and flexibility of IRAs and 401k’s comes about because they aren’t “products” or investments themselves, they’re simply tax-advantaged accounts in which individuals purchase stocks, bonds, or funds, and in which they can sell and rebuy different assets without incurring any tax consequences. LIRPs are a product that you buy and are stuck with.
There’s much more I could add. Main things I would say, though, are beware of any investment insurance products. Buying cheap term life insurance (if you need LI) and investing the rest of your savings within tax-advantaged acccounts is usually preferable. Simplicity and having a full understanding of your investments, and where and what fees are being taken out, is important.
Several others have mentioned Mr. Money Mustache as good source for retirement advice generally, and of investment advice in particular. I agree, that guy is quite good. The bogleheads forum and wiki is probably the best resource out there, as always there are some people there who may not be great but there are quite a few extremely knowledgeable people behind that site. And “bogleheads” is named after Jack Bogle, long time CEO of Vanguard funds, which is one of the few companies in the industry that is “consumer friendly”. Not coincidentally it’s a co-op structure, so there is no built-in conflict of interest between the management and its customers. Almost all companies in investment industry make money from fees, and of course for investors (i.e., their “consumers”) the best thing is to avoid having fees taken out. You can see the conflict. IMO, It’s quite an ugly industry. The usual modus operandi for an investment company is to convince consumers that the company has special expertise and/or complicated products that are worth paying, usually combined with making it hard to figure out all the fees.
Anyway, I’m rambling now, but Money Mustache, and especially Bogleheads are solid resources to start with. Along with any book by John (Jack) Bogle. It’s worth spending some time, especially when you’re young, to come to conclusion that low-fee index investing — combined with some common sense, skepticism, wariness — is best way to invest.
Geeze, quite a comment, thanks.
I looked into LIRP’s a little bit more after writing this post. For our income levels, they don’t make sense: given the balances of our 401(k)’s, our mandatory withdrawals are not yet approaching the point that they will exceed the standard deduction, which McKnight wisely offers as a threshold for tax-deferred accounts.
Your comment about fees is also spot on. I ran a 3-year simulation assuming 1.5% LIRP fees versus 0.1% 401(k) fees. Post-tax returns were about the same, but once you account for LIRP’s not being tax-deferred, a low-fee 401(k) comes out ahead. This is yet another example of the importance of low investment fees — if you’re willing to manage your own money, it’s likely worth tens of thousands of dollars, perhaps hundreds.
No-one dumber than someone who knows it all. As a Financial Advisor who sells primarily 401(k)s I can tell you, you’re way off base. Fees on almost every last 401(k) program and it’s related kinfolk,i.e., 403(b)s, 457s, etc. are between 3.0 and 4.5% PER Year. It’s just not well disclosed. You have to read the, and understand, the 300-400 page document that your H.R. Dept never provides you, but it’s all in there. Why do you think the D.O.L. was planning to take over administration of ERISA accts. this year if not to both disclose and lower those fees? The mutual funds in those accts. have 1.5% operating costs (buy & sell) same as if you buy them directly, plus profit for administrator of the fund plus costs in dealing with government regs, etc. “0.1% 401(K) fee” Not in this lifetime.
The cost plan participants actually pay vary widely from plan to plan. I work for one of the largest 401k providers in the nation and most participants pay fees solely based off how they choose to invest their money. Most plans offer institutional class index funds with under .1% expense ratios. I currently have an index fund well under .1% and a variety of active funds under 1%. All of my contributions are made on a Roth basis, which is an increasingly available options in 401ks. you would be hard pressed to find any insurance product that will deliver more actual usable after tax money in retirement than a Roth 401k with $18k contributions limits, no phaseouts, and very low costs borne by the participant.
I continue to be appalled by the way so called “financial advisors” (insurance salesman) twist words to sell high fee products that fleece investors and line their own pockets with commissions. They are why DOL came down with a regulatory hammer.
Sorry for hard-to-follow and error-ridden previous message. One follow-up would be to add that perhaps the best investment book out there — which will reward all time you spend reading (and re-reading) from cover to cover — is Bernstein’s Four Pillars of Investing.
The question of which is better, Roth vs a traditional IRA ( or 401k ) is an interesting one. A couple of factors which argue in favor of the traditional IRA which I did not see mentioned are the tax savings that you receive immediately when contributing to a traditional IRA or 401k. These saving may allow you to invest more money in the present than investing in a Roth and those additional investments will grow over ‘x’ years until retirement. Another factor to consider is that your income in retirement will likely be lower than it is now so the tax rate you pay in retirement will be lower, all else being equal. I am also very skeptical about prognostications on future tax rates or economic conditions. I don’t think anyone can do this with any accuracy. The only thing we can be certain of is we can’t be certain about anything so I think you can make a good case for saving a buck now – which can be invested for retirement or whatever – as opposed to saving one later. Personally I hedge my bets by using all of the above for retirement savings. You are also well ahead of many if you are simply learning about these issues and saving for retirement using a Roth, 401k, or traditional IRA.
There are many reasonable comments both in the initial review and subsequent. And some comments loaded with presumptions that aren’t as simple as presented.
The basic axiom of saving for any goal is simple. Every dollar you save today means less money that you will need to scrounge tomorrow. Period. Even if you are the worst possible investor and lose 50% a year, someone who puts away $100 a year, will after 25 years, have more than the person who put away nothing. As simple as it sounds, in any discussion on retirement savings, you need to start here: For the simple reason that given contradictory information, human nature would have us put the whole thing off.
Once we pass this hurtle, the “best” plan really takes the personality of the individual into account. The fact is given the choice, the majority of people will chose not to save. Not just American, everybody. Mass media ensures this mindset. So what ever you can do to get yourself to save is important. Even if others don’t feel that it’s the wisest choice, or agree with the under lying principles. The largest homogeneous group of millionaires in this country include many who are so begrudingly: Retired ATT employees. See back in the ’60s, bad old ATT required that you put a percentage of your earnings into a company savings plan. Some liked the idea, others bristled. So, whether you agree with someones chosen method of savings, it’s a good thing. Period.
What is the best method/plan? Again, that depends on the individual. Before you dismiss that out of hand, keep in mind that fully half of all folks that don’t escrow their real estate taxes need their income tax refund to pay them. Some feel that is an obscene way to save. I say, if it works for you, it’s better than loosing your home.
There’s a couple of comments I read that I don’t feel quite hit the nail on the head: Long Term Care insurance premiums, like all medical expenses, may be deductible, but only to the extent that they exceed 10% of AGI. So let’s not pretend that it is some sort of “instant write-off”. Also LTC premiums, if unused, are funds gone for good.
It’s nice to believe that most 401ks have fees of less than 1.5%. Moving forward this will be true. But it certainly isn’t today. The result will be that ever provider will react by lowering their fees.
BTW, the Fed’s concern over fees didn’t come along because government is concerned about you…. One of the biggest selling points to rolling over your 401k to an IRA are the higher 401k fees. The Feds have been exasperated because their work force is aging and retiring too, and rolling monies out of their equivalent of the 401k. (The irony is that the US Govt plan has the lowest costs of any plan). This is causing a problem because, just like the SSA fund are just IOUs, so is the Fed’s employee savings plan. So this is a plan to stem the tide of money rushing out of the Fed’s coffers.
I hope you leave with the simple presumption that savings is good. And whatever vehicle you start with, you’ll be better off than by doing nothing. As to the “best” way, well that simply ignores this basic precept and assumes you are much further down the road in fine tuning a plan that you have yet to commit to…
Andrew you might look into dividend growth investing. Explanation here – http://seekingalpha.com/article/2899796-the-dividend-growth-investing-mindset
To state that piling as much as you can into Roths during working years is always better than paying any income taxes in retirement is terribly misguided. In my highest earning years, I am deferring at 25% Federal, 8% state with traditional. I would much rather pay 12% Federal for much of this in retirement (up to first 89K per year, not to mention nearly 30K standard deduction).. By paying zero in retirement means that you are not leveling out income to consistently take advantage of the lower brackets each year.