Earn Billions Tax Free: Unlocking the Power of Roth IRAs

September 28, 2021

Investing

Shmelke Gebber loved investing, but high taxes chopped down his portfolio’s impressive growth significantly. That’s why he was intrigued when he heard that a West Coast billionaire had grown most of his fortune tax-free. Peter Thiel, one of the founders of PayPal, had somehow sheltered $5 billion of investment profits in a humble Roth Individual Retirement Account (IRA). In just a few years, the 53-year-old will be able to withdraw all of those gains without paying a nickel in tax!

How did Thiel turn an IRA, which allows very limited contributions, into a tax-free colossus? More importantly, can we tap into the same strategy?

Tax Mitigation for All

Liberal journalists at ProPublica have been using stolen IRS data to expose how America’s wealthiest finagle their way to lower tax bills. While these articles’ headlines imply that nefarious strategies are being used, so far, there’s been no smoking gun. Though some wealthy people do use complicated or even questionable tax-saving techniques, Thiel’s usage of a Roth IRA to shelter immense investment gains was quite straightforward—and anyone can utilize the same strategy to earn tax-free investment profits.

Thiel’s Investment Magic

Thiel’s tax-free billions stem from two combined factors: his unbelievable investment gains coupled, with shrewd usage of a simple tax shelter. In 1999, a little-known Peter Thiel with a reported annual income of just $73,263 placed $1,700 in a new Roth IRA account. As the founder and CEO of fledgling tech start-up PayPal, Thiel had access to dirt-cheap, pre-IPO shares, so he used the $1,700 to buy 1.7 million shares of PayPal stock (for a 10th of a penny each) and let the tech boom work some magic of its own.

Within a year, the value of those 1.7 million shares was $3.8 million. In 2002, eBay bought PayPal, and Thiel sold his shares for almost $24 million! No tax was owed on the sale because the proceeds remained in the Roth IRA account. And that cash was then put to work, invested in multiple additional tech start-ups. In 2004, $500,000 from Thiel’s Roth IRA account helped a young Facebook to develop. Palantir was another unicorn start-up partially funded by Thiel’s swollen IRA. All in all, the original $1,700 grew into a mind-boggling $5 billion as of 2019.

Thiel’s Tax Magic

Even if Thiel would have to pay the highest tax rates on this bonanza, he’d remain a multibillionaire. But because the aforementioned technology investments occurred within a Roth IRA, the resultant massive gains were not taxed, even as they were traded. And when Thiel reaches the IRS’s official retirement-age cutoff, 59.5 years, he can remove every penny of those billions from the IRA account tax-free.

But he probably won’t remove much, living instead on his assets that are not tax sheltered. He will keep accruing his Roth IRA wealth, out of the reach of the IRS. Upon his death, his beneficiaries will get the whole pot without needing to pay any capital gains tax (estate tax is another matter). And while journalists, politicians, and some citizens may be frustrated, Thiel followed the simple structure of the law, no shtick involved. Congress could have put a dollar limit on the sums that Roths could protect…but they didn’t.

Spending Hundreds to Save Billions

Most people who do tax planning are focused on lowering their (or their clients’) current tax bills. Therefore, when using IRAs, they tend to put in their money pre-tax, using a traditional IRA, which offers an immediate deduction in taxes owed. This pre-tax money is then invested and grows tax sheltered. But when removed from a traditional IRA’s shelter, every dollar of principal and growth is fully taxed. By using a post-tax Roth IRA, Thiel took the long-term view. And by paying a bit of tax on the $1,700 in funds he originally put into the Roth IRA, he saved billions in the long run.

Pulling Off a Thiel

The story of a (Trump-supporting) billionaire getting away with a massive tax discount has Democrat politicians hopping mad. ProPublica hopes that the fury ignited inspires Congress to cap the amount that can be sheltered by Roth IRAs. But proposed limits on the amount eligible for Roth IRA protection would likely be quite high anyway. Traditional IRAs may be the best option in some scenarios, but many times, Roth IRAs should be used to permanently shelter investments from any taxation.

Either way, Thiel should be mostly in the clear. To retroactively tax just his Roth IRA is probably unconstitutional, and it’s way past the statute of limitations to question the valuations of the pre-IPO shares.

Maximizing Tax Protection

People who use IRAs or 401(k)s often waste the tax-fighting power of such vehicles. Dollars are placed into these accounts, and then they sit there in low-yielding cash, bonds, or maybe even whole life insurance. What a waste. If the protected investments barely grow, the tax shelter is much less valuable! Thiel’s case is an extreme one, but it illustrates the potential strength of a straight-forward tax shelter. IRAs and 401(k) accounts can even be used to invest in start-up businesses, cryptocurrency, hard-money loans, or individual stocks—investments that have much higher growth potential than cash, bonds or run-of the-mill stock mutual funds.

The Nuts and Bolts

Note that I’ve glossed over the technicalities of putting a Thiel-type Roth IRA in place. Roth IRAs have contribution income limits. But with a bit of maneuvering, almost anyone can get tens of thousands into Roth IRAs annually. Also, the typical IRAs and 401(k) accounts on offer from your bank or employer won’t allow the investments that can benefit the most from sheltering; you need to utilize a “self-directed” account with a specialized custodian. None of this is rocket science, but the advice of a well-schooled financial adviser may be helpful.