RPF0653-How_Tax_Rule_Changes_Can_Sink_Your_Financial_Plan_Discussion_of_H.R._1994-the_SECURE_act
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00:00:14.720 | Welcome to Radical Personal Finance, a show dedicated to providing you with the knowledge,
00:00:18.720 | skills, insight, and encouragement you need to live a rich and meaningful life now while
00:00:23.280 | building a plan for financial freedom in 10 years or less. Today on the show, we're going to dig into
00:00:28.480 | a piece of pending legislation in the United States Congress and use it to bring out a couple
00:00:34.400 | of practical examples that I think will be helpful to you and to me as we try to think about some
00:00:40.080 | practical financial planning tools in our own portfolios and as we try to discern the future.
00:00:44.800 | I think it's an illustrative example and so I'm ready to use it as a teaching point for you.
00:00:51.280 | The specific piece of legislation that I'm referring to is something called the SECURE
00:00:56.800 | Act. The technical name for this legislation is in the House of Representatives H.R. 1994,
00:01:04.560 | setting every community up for Retirement Enhancement Act of 2019. There is a corresponding
00:01:10.960 | Senate version of this legislation called the Retirement Enhancement Savings Act, but usually
00:01:18.480 | this is being referred to as the SECURE Act. For context, I'm recording this podcast on Monday,
00:01:24.560 | July 15, 2019. As things stand currently, this bill is not yet the law of the land.
00:01:32.480 | This bill was passed, the House version of this bill was approved by the U.S. House of
00:01:37.920 | Representatives on May 23 in a vote of 417 to 3. So an overwhelmingly,
00:01:45.440 | an overwhelming vote, almost unanimous, of 417 to 3 in favor of the House bill. Now,
00:01:54.080 | the normal process, it's my understanding that the normal process for this was going to be that
00:01:59.120 | the Senate would try to pass its own bill called the Retirement Enhancement Savings Act and then
00:02:05.040 | try to bring any gaps or discrepancies between the House version and the Senate bill together
00:02:11.120 | in conference. However, it's my understanding that a little bit because of the overwhelming
00:02:16.880 | nature of the House vote, the leaders of the United States Senate decided to go ahead and
00:02:22.720 | just try to use a legislative maneuver called hotlining and hotline the SECURE Act, which
00:02:29.040 | basically means to try to bring this legislation and secure unanimous consent by all senators,
00:02:34.720 | and then just simply pass it through the House through this hotlining process.
00:02:38.160 | Now, if, so this would only work if no senators object to it under the idea of unanimous consent.
00:02:46.640 | If any senators object to the House version of the bill, then it has to go on hold and it has
00:02:52.640 | to be debated and further changes brought in in some way. At the moment, it seems as though
00:03:00.880 | one senator is publicly causing problems for this bill, Senator Ted Cruz from Texas,
00:03:06.480 | evidently, according to news reports, objects to the bill and objects to the fact that in the final
00:03:12.400 | version of the House bill, some provisions that would allow 529 educational savings account funds
00:03:18.240 | to be used to pay for homeschooling expenses were removed and also some other idea for uses of 529
00:03:25.680 | funds as well. It's possible that there are other senators objecting as well because holds can be
00:03:29.520 | placed on the legislation anonymously. So that's where things are in terms of a legislative process.
00:03:35.920 | We simply don't know if this bill will become law. We don't know if the US Senate will pass it. We
00:03:42.800 | don't know if the president will sign it. So from that perspective, I am a little bit premature
00:03:48.000 | in talking about it. However, I want to use this because I think it's an important example of just
00:03:54.720 | how quickly things can change when your plans are reliant upon laws, legislation, and policy
00:04:02.320 | of the government, especially as it relates to taxation. What is in H.R. 1994? What does it
00:04:09.680 | actually say? Well, there are a bunch of different provisions in this legislation. Here I'm just
00:04:14.800 | going to go with the House legislation and discuss that because that's what's actually been passed.
00:04:19.680 | These provisions in the legislation range from fairly small to very industry-specific to some
00:04:26.800 | very big things that will affect mainstream financial planning. There are a number of just
00:04:33.680 | very small specialty issues in this bill, and then there are a number of things that are more
00:04:38.960 | on the corporate side of the financial planning space, some changes of different plans that can
00:04:46.000 | be offered and things like that. But there are some provisions in this legislation that would
00:04:50.400 | make a big, big deal, that would make a big, big change in terms of average financial planning.
00:04:56.240 | Now the changes in 529 plans are one of those examples. Over the years, 529 plans have become
00:05:04.240 | increasingly attractive. I have here on Radical Personal Finance talked about why 529 plans are
00:05:10.480 | so attractive. I've tried to disabuse you of the idea that 529 plans are a great tool in the way
00:05:17.360 | that they're often used by parents saving for their child's college. I've tried to show how
00:05:22.560 | the potential tax savings are relatively modest for a so-called stereotypical average family who
00:05:30.240 | is putting $100 a month into a college fund starting when the child is 10 years old and
00:05:34.240 | is planning to take it out at 18 years old. And I've tried to show how the savings in that type
00:05:38.080 | of plan are very, very modest. However, 529 plans are very useful because they can be front-loaded
00:05:44.720 | with lots of money. They are protected from the claims of creditors, and so that can be very useful
00:05:49.840 | in terms of a simple asset protection plan. They're very, very useful from an estate planning
00:05:56.080 | perspective because they are considered to be a gift for estate tax planning purposes. They're a
00:06:03.520 | completed gift where you're actually making a transfer into the account for your child,
00:06:08.560 | thus removing funds from your estate. But you still have the opportunity to change the
00:06:12.720 | beneficiaries to control the account. There's a high degree of control available for you
00:06:17.040 | in establishing one of these accounts. And so I've tried to show how they actually can be very useful
00:06:21.920 | for many people. Just I don't love them in their mainstream application. I love them in some of
00:06:28.240 | the more radical applications. Now, a couple of years ago, 529 plans became much more attractive
00:06:35.120 | because now the use of 529 plans has been expanded from K through 12. I guess this was last year,
00:06:41.440 | I think, from K through 12 private school education. So now you can use these to fund
00:06:47.360 | not only college expenses, but appropriate K through 12 private education. That's a big,
00:06:52.800 | big deal, and it really enhances the usability of a 529 plan because many families, especially
00:06:59.360 | many families, would like to save for their children's college, but they're also going to
00:07:04.560 | be committed to making payments for private school tuition along the way. And a 529 plan
00:07:10.160 | allows you to set aside the money for those payments to use it in a tax efficient way and
00:07:15.280 | to fund those K through 12 expenses. Now, again, there could be some tax savings, but the tax
00:07:20.640 | savings will work out best if you have a very young child and you're using the money and you
00:07:27.360 | can get a lot of gain. I don't think the tax savings are the number one reason to use a 529
00:07:32.880 | plan. I think it's useful, but it would work if you have a very young child and you're planning
00:07:37.440 | for college. But if you're planning for a five-year-old's expenses at age 10, five years of
00:07:42.400 | earnings on an investment is likely not to be so, so significant. But it can be there. Not denying
00:07:49.040 | it can be a factor, just that it's not the number one factor. In my mind, this K through 12 opens up
00:07:54.000 | a tremendous possibility for wealthy parents, wealthy grandparents to fund an expense that
00:08:00.240 | they're committed to, often high-priced private school tuition, and to do it in a way that is
00:08:06.240 | very flexible and allows them to protect the funds that they have from the claims of creditors.
00:08:11.840 | So this is what I really love about 529 plans. Parents, grandparents can put 50 grand, 100 grand
00:08:17.120 | into an account, set it aside. It's not inside of a trust, but it is protected from the attacks of
00:08:22.480 | creditors and they can fund that educational expense and they can do that from K through 12.
00:08:27.360 | And in my opinion, it's far more important to heavily fund an excellent primary school and
00:08:34.880 | secondary school education than it is to fund a college education. Any student who is bright and
00:08:42.320 | who is capable academically can fund their own college education with just working at McDonald's.
00:08:50.080 | And then there's massive amounts of money available for any student who is good at academics,
00:08:56.560 | available to pay for them to go to college. Many students can get paid to go to college.
00:09:00.080 | But that's not the same way for K through 6 expenses or 6 through 12 expenses. Those are
00:09:05.680 | the years where there simply aren't many scholarships available. The student obviously
00:09:10.080 | can't pay for it themselves. I don't mind expecting an 18-year-old to pay for their
00:09:14.560 | own college education. But even as much of a radical as I am, I don't expect a 6-year-old
00:09:20.080 | to pay for their private school education. That's obviously unreasonable. So it's much
00:09:25.600 | more valuable for, in my opinion, if a parent had to choose between prioritizing educational
00:09:31.920 | funds for college versus prioritizing educational funds for first grade, second grade, third grade,
00:09:39.520 | fifth grade, I would rather they prioritize those funds for first, second, and third and
00:09:44.000 | let the child deal with college on their own. The reason most people don't think this, of course,
00:09:50.240 | is because of the fact that you don't have to pay out of pocket to put your child into a government
00:09:55.120 | school. There's no out-of-pocket expense for that. And so most people don't think of paying for
00:09:59.680 | K through 12 primary and secondary school education. They think of paying for college
00:10:03.600 | because the number of government colleges that is available without tuition is rising, but is still
00:10:10.400 | almost non-existent compared to the number of K through 12 government schools that can be had
00:10:14.480 | without paying tuition. But if you put your child in a government school, you get general government
00:10:19.840 | school results generally, which on the whole are not particularly good. So I would rather see those
00:10:25.040 | dollars prioritized through K through 12 than it through college, just from an analytical perspective.
00:10:30.320 | If you have to choose between them, it makes more sense to me to prioritize it in the early years.
00:10:34.960 | And now that the 529 plans are opened up to that, that's a big, big deal. It makes them very, very
00:10:39.120 | useful. So I've grown over the last three to four years to think much more highly of 529 plans than
00:10:46.000 | I did previously. There are good investments available, low-cost investments. You can use
00:10:51.360 | the state that best serves your situation. A small number of US Americans will get some defray of
00:10:58.000 | their state-level income taxes with the 529 plan. So that can be helpful as well. Now, the thing
00:11:04.240 | that 529 plans haven't covered thus far is homeschool expenses. And if they did cover homeschool
00:11:08.480 | expenses, I would now become probably one of the biggest cheerleaders because, of course, I think
00:11:13.440 | that dollars go much farther in homeschooling or some kind of looser educational system that doesn't
00:11:20.560 | just follow the factory school model. But unfortunately, thus far, it's not the case.
00:11:25.680 | Now, will this legislation change that? Maybe. Time will tell. At the moment, I don't expect it
00:11:30.960 | to. In general, when you start talking about homeschooling in any way, you have to go up
00:11:36.720 | against the teachers' unions and the government school cartel. And in general, they are very,
00:11:44.000 | very powerful, especially politically. And that's my understanding of what happened with the House
00:11:48.240 | Bill. The previous House Bill did have provisions in it that allowed for 529 accounts to be used to
00:11:55.360 | pay for homeschool expenses for K-12 students. And then at the last minute, due to the pressure
00:12:00.960 | from the teachers' unions, the House of Representatives pulled that provision.
00:12:04.560 | Will it come back? I doubt it. But time will tell. That was a bit of a discourse on 529 plans,
00:12:11.360 | but it's not the main focus as far as the biggest threat of what this legislation would be for a
00:12:17.360 | broader audience. There are other benefits in the HR 1994 legislation, and some of these other
00:12:25.760 | benefits of the HR 1994 legislation are actually quite interesting and useful. So, for example,
00:12:31.920 | there is a provision that would allow penalty-free withdrawals from retirement plans for individuals
00:12:36.640 | in case of the birth of a child or adoption. I like that. I'm happy to have those provisions
00:12:43.280 | if they are in the final legislation as it is passed. One bit of change in the law is some
00:12:51.440 | change in the rules, where there's an increase in age for required beginning date for mandatory
00:12:56.080 | distributions. That's only modest. I think it goes from 70.5 to 72. But a bigger issue for me
00:13:02.880 | is there would be a repeal of the maximum age for traditional IRA contributions. That's useful to me
00:13:09.760 | as well. But there are some downsides. Let's get to the number one biggest threat here with this
00:13:15.520 | particular legislation. And that is the change of what we in the financial planning business call
00:13:22.240 | a stretch IRA. The change in rules that would basically eliminate the usefulness of a stretch
00:13:30.160 | IRA. First, let's explain how the law is right now so you can understand the benefits of a stretch
00:13:35.360 | IRA. And then we'll talk about how utterly destructive this legislation is to this particular
00:13:40.880 | strategy. As things stand right now, if you are the owner of an IRA, and that IRA can be a
00:13:48.480 | traditional IRA or that IRA can be a Roth IRA, then you have certain rules that govern you,
00:13:56.160 | and then you have certain rules that govern the beneficiary of that account in the case of
00:14:01.360 | your death. Now, if you own a Roth IRA, then because you have already paid the income taxes
00:14:08.880 | on the account, the way things stand right now, you can own that account for your entire lifetime,
00:14:16.000 | and there are no required distributions from the account. So the account can continue to
00:14:21.440 | accrue and grow throughout your entire lifetime until your death. If you own a traditional IRA,
00:14:28.080 | you can own that account through your death, but starting at the age of 70 and a half,
00:14:32.560 | you're required to make certain distributions from the account. Those are called required
00:14:37.440 | minimum distributions. And they come out because you fund a traditional IRA with money that you
00:14:43.360 | haven't paid income taxes on yet. There's a formula that makes the money come out that you
00:14:48.800 | calculate to decide how much needs to be distributed, and that formula is based on
00:14:53.040 | your life expectancy. So when you are 70 and a half, it's a small percentage of the account.
00:14:59.920 | When you are 90 and a half, it's a larger percentage of the account. So increasingly,
00:15:04.160 | more and more money comes out of the account. Now, for many people who have a small amount of money
00:15:09.040 | in an IRA or a Roth IRA, these rules are relatively immaterial. They want to take the
00:15:15.040 | money out and spend it on retirement. That's their basic idea that they, that's why they
00:15:20.320 | invested. And they don't have enough money to have a lot left over when they're dead.
00:15:23.760 | They're just focusing on having the money and using it to pay for retirement. So most of these
00:15:29.200 | changes or even changes in rules would be relatively immaterial. However, for the radical
00:15:34.080 | personal finance audience, we're not the normal person. Rather, we're looking to exploit the rules
00:15:39.920 | and say, "Can we, following the law, get major, major benefits that are not available to other
00:15:45.520 | people?" And for those, it are not available if we just use up all the money. And in those contexts,
00:15:51.920 | a tool like a Roth IRA can be an extremely powerful tool. If you can set aside a stash of cash
00:15:58.720 | and then leave it alone for a long period of time, it can grow to be a huge asset for your
00:16:05.040 | beneficiaries as part of your estate. Let me give an example of how reasonably this can be done.
00:16:10.400 | Let's assume that a 50-year-old can successfully save and accumulate $50,000 in a Roth IRA.
00:16:17.440 | So we're going to begin with a present value of $50,000. And let's assume that that 50-year-old
00:16:22.720 | doesn't need this particular account to pay for their own retirement expenses, such as they are.
00:16:28.160 | So they can keep this money invested in this account. Let's further assume that this 50-year-old
00:16:33.440 | is able to live to a total of, let's say he was 95, to age 95, for 45 years of total lifespan.
00:16:42.400 | So that gives us 45 years of investing. And assuming that this 50-year-old can invest and
00:16:47.760 | earn, say, an 8% rate of return, this one account of $50,000, because it has 45 years available for
00:16:55.520 | it, can become worth $1.6 million at their date of death. If they could earn a 10% rate of return,
00:17:03.760 | it could be potentially $3.6 million. So there's major value in a 50-year-old accumulating this
00:17:11.120 | and setting it aside as a primary asset for their children. One of the best assets we
00:17:18.720 | traditionally teach in good financial planning, we traditionally teach that one of the best assets
00:17:22.080 | for you to leave to your children is a Roth IRA. And that's because of the rules of what can happen
00:17:28.320 | when you die and you leave it behind for your children. Now, let's assume for a moment that
00:17:35.920 | you leave this asset to your child, or even better, we could do a grandchild or your grandchild,
00:17:42.240 | and they inherit it at your death. What can that person do with this Roth IRA? Well, the first
00:17:48.080 | thing they can do is they can obviously just take the money and they can spend it. They can just
00:17:51.600 | cash it all out. And if it's in a Roth IRA account, let's say they inherited $1.5 million,
00:17:57.280 | there would be no taxes due on the money. They can just simply take the money and spend it. It's a
00:18:03.360 | Roth IRA, the taxes have already been paid, now they can take the full distribution out and do
00:18:08.000 | whatever they want. If it is a traditional IRA, then they can take the full amount out, the $1.5
00:18:14.160 | million, but they would owe taxes on $1.5 million of income. So you can see here why the Roth IRA
00:18:21.280 | can be really superior. But what else can they do? Well, they can take required minimum distributions
00:18:28.240 | over a couple different options of person's life expectancy. So they could take it off of your life
00:18:33.440 | expectancy, but if you're leaving it to a child, they can take the required minimum distributions
00:18:38.640 | out on their own life expectancy. So if you left this behind for a 10-year-old or a 15-year-old
00:18:46.000 | or a 20-year-old, you can imagine how low the required minimum distributions are from this
00:18:52.000 | account. Now, if you have $1.5 million that's tax-free, and you leave it behind as an asset
00:18:58.400 | for a young person, that $1.5 million can basically become a trust fund that provides an income,
00:19:05.760 | a lifelong income for the young person, and in many ways could provide for the retirement security
00:19:13.200 | of that person. And the rules around these types of accounts, I'm focusing on a Roth IRA because
00:19:18.480 | it's superior here to a traditional IRA, but the rules are applicable to both. The rules on a Roth
00:19:23.440 | IRA are so fantastic that they're wonderful. It's a wonderful asset to leave behind. First,
00:19:32.480 | you can fund a Roth IRA with just about any investment that you want. There are a few
00:19:36.720 | prohibited investments. You can't own life insurance in it. There are a couple other
00:19:40.640 | prohibited rules, but you can pretty much fund a Roth IRA with just about anything.
00:19:45.440 | So you can put a house inside of a Roth IRA. You can put a stock inside of a Roth IRA. You can put
00:19:50.160 | a mutual fund or an ETF inside of a Roth IRA. You can even put gold coins inside of a Roth IRA. You
00:19:56.240 | can put almost any type of investment inside of a Roth IRA. So this opens up a tremendous range of
00:20:03.280 | opportunities to you. Another thing you can do, though, is because of the Roth IRA being
00:20:09.440 | generally protected from the claims of creditors, you have a very safe asset that's available
00:20:14.080 | to leave behind. So similar to what would happen if you set up a formal trust for your child or
00:20:21.840 | grandchildren, the Roth IRA has many protections. It's protected from the claims of creditors.
00:20:27.040 | Your child could have a million and a half dollars in their inherited IRA, but as long as
00:20:33.840 | the money stays in that inherited IRA, it should, in most states, retain its protected status as
00:20:39.520 | being exempt from the claims of creditors. It should be an asset that can be segregated out
00:20:44.480 | in case of a divorce or other life happening that causes the child's assets to be exposed to the
00:20:51.040 | claims of creditors or other people. And so it's a very, very safe asset. But because it's a Roth
00:20:56.320 | IRA, it's eminently simple. You don't have to pay a trustee for management fees. You just pay
00:21:02.320 | a simple custodian, and the costs on these are basically non-existent. And so it's a wonderfully
00:21:07.520 | efficient asset. And if you just think, I mean, I hesitate to even do the math, but if you just
00:21:13.440 | think of how much money this can grow to if you leave it behind to a young person, and the money
00:21:21.360 | is exempt from taxes and it can come out on the young person's life expectancy over an 80-year
00:21:26.080 | period, it can be an absolutely huge asset. So given that this is so good, this has become a
00:21:33.760 | primary staple of financial planning advice. I've gone on and on about all these benefits here just
00:21:39.520 | now. And this is a major, major benefit of a Roth IRA. And it causes most people like me,
00:21:47.040 | financial planners like me, to use these as a primary tool. And you should. But now watch what
00:21:52.480 | happens if this new legislation passes. What happens if the SECURE Act becomes law and passes
00:22:00.160 | the Senate by unanimous consent? The SECURE Act eliminates the stretch IRA. The SECURE Act
00:22:11.360 | eliminates the stretch IRA. As things stand right now, the beneficiary of an account can stretch
00:22:19.360 | things out over their actuarial lifetime, which is really wonderful. But under the terms of the
00:22:27.040 | SECURE Act, a non-spouse beneficiary of an IRA has 10 years to pull out all the money inside of an
00:22:37.440 | IRA. Now here's where we're going to kind of slide to the side and morph over into talking about
00:22:45.200 | traditional IRAs instead of so much Roth IRAs. Because from a tax perspective, the impact here
00:22:52.320 | to a Roth IRA is not so substantial as the impact to a traditional IRA. The reason is that when the
00:22:59.360 | assets come out of the Roth IRA, they're going to come out tax-free. So yes, you don't get to
00:23:03.360 | maintain the tax deferral over a long period of time. You just have to take the money out. It's
00:23:09.360 | basically going to be kicked out and you have to spend it. So, okay, big deal. But what about the
00:23:14.640 | tax planning for a traditional IRA? And here, focus very carefully on the fact that this is
00:23:20.400 | applicable to a 401(k), traditional 401(k), 403(b), etc. All types of traditional accounts. And the
00:23:27.600 | vast majority of savings are not in Roth IRAs, but in these types of traditional accounts.
00:23:33.040 | So imagine here that a parent, let's say that I set aside and put $20,000 per year into a 401(k)
00:23:43.200 | and then I happen to die at 50 years old and I've accumulated half a million dollars in my 401(k).
00:23:49.200 | Now, this is a very normal scenario for people who are in the upper, the top half of median income
00:23:59.040 | earners who are contributing to retirement accounts, etc. It's not normal. Most people below
00:24:03.120 | the median income earners don't have retirement savings, etc. But it's normal for the audience
00:24:08.480 | of radical personal finance to put aside $20,000 per year into a 401(k). Well, in this situation now,
00:24:15.040 | my wife could inherit the money, but if I leave the money to my child, now my child has 10 years
00:24:22.000 | to get the money out of the IRA. Now, let's assume that you are a child and you inherit $500,000
00:24:28.160 | in an IRA. And let's assume now that you have 10 years to get the money out.
00:24:36.160 | You do the math and you can see how big of a deal this is going to be from an income
00:24:43.200 | tax perspective. Let's assume for a moment that I die and I leave an 18-year-old child
00:24:50.080 | behind. My 18-year-old child inherits my half-million-dollar IRA that was my work 401(k).
00:24:56.160 | Now that 18-year-old child has $50,000 of income coming in, if they're going to take it out in
00:25:02.000 | equal payments for the next 10 years, $50,000 per year, I have just destroyed any ability of my
00:25:10.640 | child to qualify for scholarships. I've just destroyed any ability of my child to get financial
00:25:19.680 | aid, student loans, major changes now because my child has $50,000 of income. Or what if it were
00:25:31.600 | more? What if I left behind a million-dollar 401(k) and now it's $100,000 per year and now my
00:25:38.080 | child has $100,000 of income coming in on top of their salary? You can quickly see how under the
00:25:49.760 | progressive tax system of the United States, a major, major portion of that account would be
00:25:55.040 | lost to income taxes. Now first, let's talk about is this fair, right? Is this just? Well,
00:26:02.560 | I understand the arguments that would be in favor. For example, let's say we can cry big tears for my
00:26:08.640 | college student who can no longer qualify for financial aid and who can no longer qualify for
00:26:14.080 | scholarships because I have $50,000 of income and say, "Look, they have $50,000 of income. They
00:26:19.280 | should pay for their own school." Okay, that's a fair point. I don't think that's wrong.
00:26:24.880 | I don't know in this situation that we can make an argument one way or the other. We can start at
00:26:29.680 | the basis of should there be taxation at all? That's a fair argument. But I think in this
00:26:34.960 | situation, you can understand why the people voting for this legislation would certainly say,
00:26:41.600 | "Well, big deal. So what? A rich person has millions of dollars in their IRA and so what?
00:26:46.640 | Their kid has to pay taxes." Fine. You can understand how they would do that, which is why
00:26:50.800 | this legislation passed 417 to 3 in the House of Representatives and there's a decent chance that
00:26:56.000 | it'll pass unanimously in the Senate. Time will tell. So you can understand why the proponents
00:27:01.120 | of this would try to make these changes. But as far as I'm concerned, this is a good example of how
00:27:11.840 | governments default on their promises by changing the law.
00:27:19.520 | That basically when you're dealing with government, you're not dealing with a person
00:27:23.360 | who can be held accountable to fulfill their word, to fulfill a contract as agreed upon.
00:27:28.480 | Rather, you're dealing with an entity that can be moved by the winds of the day.
00:27:32.480 | So if you and I made an agreement and you and I made a contract and I said, "I will allow you to
00:27:38.240 | do this and you'll get these benefits," then you would expect those benefits to continue.
00:27:44.480 | But when you're dealing with government, you don't have that. You don't have a contract.
00:27:49.600 | They didn't give you a contract when you participated in their IRA scheme.
00:27:52.560 | They just simply said, "Hey, do this and you'll have it," and then they changed the law.
00:27:57.280 | And this is why I really wanted to bring this subject out. Because everything,
00:28:02.160 | every kind of government program, every kind of government scheme, every kind of government tax
00:28:08.880 | law, all of these are run by the same basic concept. There is very little stability or
00:28:14.800 | consistency to this. It has more to where you can say that this is the way it's going to be,
00:28:19.120 | has much more to do with where are the tides turning at the moment.
00:28:23.440 | So the laws on IRAs changing, this is not changed, this is changed all the time.
00:28:29.280 | They have changed again and again. Sometimes they change for our benefit. Sometimes they change
00:28:35.040 | against us. But we don't have any choice, any control over their changing. The moral of the
00:28:42.640 | story is that you need to assume any time you're making decisions that involve government legislation,
00:28:50.560 | government rules, you need to assume that you're dealing with a fickle partner that can basically
00:28:57.680 | at any time with a little bit of advance warning due to legislative process change all the rules
00:29:03.680 | completely and completely destroy what you're trying to do. Now, does this mean that a Roth
00:29:11.600 | IRA is a terrible deal or a traditional IRA is a terrible deal? I don't think it's a terrible deal,
00:29:15.360 | no. But if your strategy is 100% predicated on this one thing going, if your counterparty is
00:29:25.120 | the government, is the US federal government, you cannot trust them. You cannot trust them
00:29:29.600 | not to change the rules. Why am I bringing this out? Well, there is an important question that
00:29:35.840 | needs to be asked. Any time you deal with a governmental entity, can we trust them to keep
00:29:42.800 | things the way they are? And in personal finance discussions, there is a broad range of trust.
00:29:49.280 | There's a broad range of confidence that different people have. And I've thought through this
00:29:53.200 | question and been exposed to the different extremes that, and I've never quite known how to
00:29:58.800 | work it and to find the answer that I could put my own feet on. For example, there are people who
00:30:05.120 | will give you the advice and say, "You should always participate in a program like IRAs, 401ks,
00:30:12.800 | et cetera, because they're the very best thing and you'll save tons and tons of money. You should
00:30:18.240 | always fund your 401k first. You should always fund your Roth IRA first because it'll save you
00:30:22.720 | tons of tax money." That's the mainstream financial planning line of argumentation.
00:30:29.280 | From a mathematical perspective, it's really hard to argue with that. And you look at it and you
00:30:34.880 | say, "Yeah, these can be compelling benefits." I've tried to show you how compelling a Roth IRA
00:30:41.840 | can be. I didn't go into too many details, but as far as calculating the tax consequence, but
00:30:47.040 | these are compelling benefits. But on the flip side then, there's a more extreme, usually a
00:30:52.400 | fringe group in today's world where people say, "You should never participate in an IRA. You
00:30:57.120 | should never participate in a 401k because the government's just going to tax that money anyway."
00:31:02.000 | Well, are they right? I don't know. I have a very hard time seeing the support for that fringe view.
00:31:10.960 | And the reason I say that is because I think that once these programs get so established,
00:31:16.320 | I think there would be an outcry if, for example, if today the US federal government started to
00:31:27.360 | impose a new tax on Roth IRAs, I think there would be enough of a voter outcry to stop that. I do.
00:31:36.000 | Now, can I prove it? I can't prove it. But I think enough people have Roth IRAs and enough people
00:31:40.560 | would feel like they were being tricked, that there would be enough of an outcry that the
00:31:43.920 | politicians would scurry away and not change the rules. But I can't say that that's going to be
00:31:49.280 | the same way forever. And that's where I've always struggled with that extreme fringe view, where I
00:31:54.080 | say, "You know, I don't trust the government either, but it seems like I've got to make a
00:31:59.920 | test here of the political will." So it's important now to look at legislation like this. This
00:32:06.160 | legislation, if it passes, dramatically, dramatically devalues retirement accounts.
00:32:13.840 | It makes a huge, huge devaluing in retirement accounts. And it can very substantially point
00:32:22.160 | us in a totally different direction. For example, if this legislation becomes a law,
00:32:26.400 | then now we're going to, I would seriously look at my investments and I would much rather leave
00:32:32.400 | investments. So I would much rather leave an investment that's a capital gain asset that can
00:32:38.880 | receive a step up in tax basis at my death and thus be inherited income tax free by my children,
00:32:45.840 | or at least with a massive step up in tax basis, then leave an account filled with untaxed ordinary
00:32:51.600 | income, which is what happens in a 401k. In this situation now, I would go back and I would say,
00:32:56.960 | "Man, I would much rather not participate in this 401k here. I'd much rather buy a piece of real
00:33:02.800 | estate or buy a stock or buy a business or some kind of capital gain asset and leave that asset
00:33:08.480 | just outright, not in any kind of qualified account to my child, maybe protect it by a trust
00:33:15.600 | instead of a qualified plan document." That's going to be a much superior tax strategy than
00:33:22.880 | the 401k. If this legislation changes, the value of your retirement account is dropped by,
00:33:31.040 | what number to use? I mean, 20%, 10%. I don't know exactly how to defend a specific number,
00:33:41.760 | but there's a massive drop in value here from your retirement account if this new legislation passes.
00:33:48.720 | So what do you do? How do you do? What do you do practically? Well, here's how I think about this.
00:33:54.960 | I'm uncomfortable with either of those extreme positions that I outlined.
00:33:59.200 | For example, I'm uncomfortable with the mainstream financial planning advice that just says,
00:34:07.840 | "Always prioritize retirement accounts," because I think they don't account for the embedded risk
00:34:15.200 | of dealing with a fundamentally uncontrollable entity such as a government where you cannot
00:34:23.680 | exert any control. You can't sue them in court because of a breach of contract. We're dealing
00:34:27.760 | in a world where, hey, the legislators said this, they were duly elected by their representatives,
00:34:32.240 | and so you're basically dealing with a fickle group of people that is going to be representative
00:34:39.360 | of the winds of the day. Now, thankfully, in the US-American system, there's a bit of a stabilizing
00:34:44.080 | influence. You have a house of representatives that is deeply responsive to the passions of the
00:34:49.360 | day. You have the US Senate, which is not responsive to the passions of the day, but is
00:34:55.440 | intended to be much slower, to make everything slow down. And you see that happening right now
00:35:00.080 | with this particular legislation. Time will tell what happens. So thankfully, there is, at least in
00:35:04.400 | the United States of America, a moderating influence due to the system of government that was
00:35:09.360 | imposed. But at the end of the day, you're still dealing with a government that views itself as
00:35:14.480 | sovereign, that views itself as the owner of your money, and views itself to have the authority to
00:35:19.920 | tax you on your money and to imprison you if you don't pay them their tribute. And so it's
00:35:25.680 | fundamentally, I think, dangerous to take the mainstream position and say, "Well, it's just,
00:35:31.680 | this is what they have, so I'll just participate fully in this program." But on the flip side,
00:35:36.000 | to totally walk away, although I understand and respect the commitment of people who do that,
00:35:42.480 | to totally walk away, I think, denies some of the practical value of these types of accounts.
00:35:49.680 | For example, I've emphasized in this show and in many shows, one of the most practical values
00:35:55.440 | of retirement accounts is not the tax savings, but the simple protection from creditors. No,
00:36:01.760 | they don't defend you against super creditors, such as tax obligations, such as court judgments,
00:36:06.880 | such as court restitution, etc. But they do protect you against the common ordinary credit,
00:36:12.160 | ordinary everyday creditors. And so these accounts are very, very powerful. For an average person,
00:36:17.360 | there is almost no better creditor protection scheme that can be engaged in than just putting
00:36:21.760 | money in a 401k account, putting money in a Roth IRA. These accounts have a huge degree of
00:36:27.120 | flexibility, and they can be leveraged by a thoughtful person. And although the legislation
00:36:33.280 | will change, I think there is enough of an advance notice that a thoughtful person who's paying
00:36:38.240 | attention can see the writing on the wall. For example, it does seem excessive to expect that
00:36:47.280 | Roth IRAs will continue in the way that they have been established. When the Roth IRA was first
00:36:53.760 | established, it was supposed to be a very small account. It was supposed to be a small account.
00:37:00.240 | But the government just doesn't give away tax-free growth and tax-free buildup for decades without
00:37:04.320 | it. It fundamentally belies the taxing nature of a government entity to say, "We're going to give
00:37:12.400 | you this account that you can build up millions and millions of dollars." So then Roth IRAs
00:37:16.320 | started to be used, and then they started to be exploited by thoughtful, intelligent people.
00:37:20.880 | You started to have rollovers. You started to have the backdoor Roth IRA develop. So far,
00:37:27.760 | thus far, the backdoor Roth IRA is still legal. But you're in a situation now where people can
00:37:32.960 | accumulate millions and millions and millions of dollars in a Roth IRA. And anytime something is
00:37:38.480 | exploited like that, it now becomes a target. And this is not new. Back in 2015, President Obama
00:37:48.240 | proposed several changes to the retirement legislation. President Obama in 2015
00:37:55.120 | proposed a budget that would impose required minimum distributions for Roth IRAs. He also,
00:38:02.080 | in 2015, proposed a cap on the amount of money that you could accumulate inside of an IRA,
00:38:09.280 | and other changes as well. So I don't feel that either of those extreme positions of, "I'm just
00:38:16.000 | not going to participate," although I understand that, or "I'm going to be all in," although I
00:38:19.840 | understand that as well, I don't think those are the right position. Here's what I think is the
00:38:24.960 | practical right position. We only have the rules and laws that we have today. And if we're going
00:38:34.400 | to abide by the law, which I think is important, it's morally right, and it's practically necessary,
00:38:42.080 | again, don't mess around with people who will put you in jail and execute you.
00:38:45.760 | Follow their rules, no matter how stupid they are, because when somebody will put you in jail
00:38:51.360 | and execute you, that will cause us to... Loses your freedom, and that kind of eliminates the
00:38:57.600 | whole idea. So we follow the law very, very carefully, and make sure that everything we do
00:39:03.600 | is law-abiding. If we don't want to follow the law, the practical way is to remove yourself
00:39:09.440 | from the laws that you don't like. So if the government imposes... If the US government bans
00:39:16.480 | alcohol, the most practical course of action is not to become a rum runner. You might be put in
00:39:24.720 | prison for that and executed. The most practical option is just move to a place where the government
00:39:30.080 | doesn't ban alcohol. Then you can maintain your freedom, and you can... It's just much more
00:39:37.040 | practical. So we follow the law. We follow the law very carefully, and especially in tax situations
00:39:42.640 | where, again, they will put you in prison for life if you don't play by their rules.
00:39:48.000 | But be practical and thoughtful, and never risk your entire plan on what the person says
00:39:59.200 | they will do. Just like in any kind of practical business dealing, you don't risk everything on
00:40:06.240 | what somebody says they will do, especially when you're dealing with a fickle and corrupt entity
00:40:11.680 | such as a national government. So use the laws that are advantageous to you. Use a Roth IRA,
00:40:17.680 | use a 401k, etc. But if you get to the point where your entire wealth is dependent upon this one rule
00:40:25.840 | staying in force, now I think you've got a risk that can't be trusted. Now I think you've got
00:40:33.760 | something that you need to adjust. And so keep that diversity there in your plan.
00:40:40.160 | There have been a number of changes proposed to the HR 1994 and a number of different
00:40:44.960 | kind of caveats to the legislation. For example, oftentimes when you see rules change like this,
00:40:52.240 | you'll see a certain cap. They'll say, "Well, we're going to cap IRAs that are more than a
00:40:56.400 | million dollars, and we're going to tax you on the excess," or things like that. It's a common way.
00:41:00.880 | And that fits in with the general ethic that you see applied by legislators. The basic idea is
00:41:06.960 | soak the rich and take care of the poor people. So we're going to give this, but we're not going
00:41:10.800 | to give it to the rich people. So you can play within those things. Make sure that your accounts
00:41:16.800 | never look like they're all that rich. Make sure that you... I don't want to give too many examples,
00:41:24.240 | but you just play by the rules and don't ever make yourself look like a big fish.
00:41:28.560 | There are ways around it, and there are always going to be ways around it. But my point here
00:41:33.120 | is don't bet the farm. Don't focus everything on just one account or one strategy. Diversification
00:41:40.240 | is important in more than just making sure you don't own one stock. Diversification is important
00:41:45.520 | in strategy because when you have multiple accounts, you have different things that you
00:41:50.160 | can draw on. This is kind of classic retirement distribution planning 101. If you have an account
00:41:55.200 | that is a tax-deferred account, if you have like a 401(k), if you have an account that's a tax-free
00:42:01.600 | account like a Roth IRA, if you have an asset like stocks that have some capital gains or throw
00:42:10.000 | off some income that are outside of qualified plans, if you have some assets that can be sold
00:42:16.400 | when you need money, if you have access to life insurance, cash values that can be accessed from
00:42:21.120 | time to time, if you have access to lines of credit, then now an intelligent financial advisor
00:42:25.440 | can sit down, bring together those different assets, look at the tax code at the time,
00:42:29.600 | which none of us can predict, and then put together a distribution strategy that maximizes
00:42:34.800 | the benefits of each of those things. So diversify. Diversify your plans. Diversify your strategies.
00:42:41.520 | There are other good things about HR 1994 if it is passed the SECURE Act. There are benefits and
00:42:48.640 | disadvantages. I don't love the insurance industry is lobbying very hard to get the annuity laws
00:42:56.000 | passed. I don't love it. Time will tell. I don't want to talk more about things because it could
00:43:03.600 | be made totally irrelevant when we see final legislation, if any has ever passed. The basic
00:43:11.280 | thing I wanted to use is to say it's not crazy to think that the laws will change. The laws will
00:43:16.800 | change. It's crazy to think that things will just continue as they always are. But that doesn't
00:43:23.360 | mean that you have to take that hardcore position of "I'm just never going to have a retirement
00:43:27.360 | account." Yes, taxes will go up. In my opinion, this is a perfect example of government default.
00:43:34.960 | This is what we can expect example after example after example after example of in the coming
00:43:40.960 | decades. The US federal government is bankrupt. They're desperately looking for money. They're
00:43:47.600 | running almost trillion dollar deficit every single year. How do you fix that? Well, you raise taxes
00:43:53.440 | and you lower benefits. How do you do that in a way that doesn't count for a political revolt?
00:43:59.360 | You do it in little bits. You raise taxes in ways that don't force a legislator to stand up in front
00:44:05.440 | of people and say, "Yes, I raised your taxes." You do it in back doorways like this. And then you
00:44:09.920 | raise it at the margin and you do it on people and you say, "Listen, who needs $5 million in an IRA?
00:44:15.440 | Of course you don't need that. And hey, these accounts were never designed to have this provision
00:44:22.720 | where you could leave it to your kids and have it tax-free for 60 years or 50 years. These accounts
00:44:27.520 | were never designed for that. So all we're doing is just closing a loophole." Never mind that they
00:44:31.520 | wrote the law that way. It was exactly what they did. They did it to incentivize people to
00:44:36.000 | participate in those accounts and then they changed the law. So the way that this is happening
00:44:43.200 | and is something that we can see again and again and again in the coming decades,
00:44:46.960 | or at least that's my guess on what will happen in the future. You judge for yourself.
00:44:50.880 | I think that's the major point I wanted to communicate in this show. My intent is not
00:44:55.840 | that you worry about HR 1994. It will impact you if you've got a huge balance in your qualified
00:45:02.160 | plans or in your Roth IRA accounts. But it's not going to be a specific negative harm to you right
00:45:08.640 | now. It just means that the great plan, if this passes, the great plan that you thought was going
00:45:13.920 | to be in place just isn't going to work out as well as you thought. But there will always be
00:45:18.720 | ways around it. You can remember this. What's the phrase that I think Jeff Schnepper loves?
00:45:24.880 | "Where there's a will, there's a lawyer." And it's a lot better and more profitable for you to spend
00:45:30.320 | your money on lawyers and financial advisors than to spend it on paying taxes. At least if you
00:45:35.360 | spend it on your lawyer and you make his Porsche payment for him, you at least are stimulating the
00:45:39.200 | economy and helping him and everyone that makes the Porsche. You're actually helping people instead
00:45:45.680 | of sending it off to make guns and bombs to control the world. So there's always a way through it,
00:45:51.920 | and you'll find it. Keep an eye on HR 1994. We'll see what happens. I would love it if the 529
00:45:57.920 | provisions were expanded for homeschooling. That would thrill me. But in general, almost none of
00:46:03.440 | us are ever happy. Probably any decent piece of legislation never makes everybody happy. It's
00:46:08.080 | always winners and losers. And that's probably, in the end, fair that it works out that way.
00:46:12.560 | So we'll deal with it as it comes along. But watch it. Watch the process, because I think it's
00:46:16.960 | instructive. Don't put all your eggs in one basket. Don't bet the farm. And I wish I could come up
00:46:22.320 | with another list of cliches to show that there's wisdom in diversifying. Don't bet everything on
00:46:28.640 | one strategy. If your entire strategy is the backdoor Roth IRA, it's not dead. It just might
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