Lazy Man and Money

Thiel’s Scandalous Roth IRA and What You Can Learn From It

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A few weeks ago, ProPublica dropped another tax bombshell. If you missed the first one* a couple of weeks ago, they published a bunch of the wealthiest Americans’ tax details when it was sent to them. They were able to show how the ultra-wealthy are able to avoid taxes.

It was a fantastic read and it might just change Congress’s tax policies going forward.

ProPublica is back this time with an exposé of Peter Thiel’s Roth IRA. It’s a little bit different in that this article focuses on one person’s Roth IRA (for the most part).

What makes Peter Thiel’s Roth IRA so amazing is that it is estimated to be worth $5 billion dollars… and he’ll never have to pay taxes on it. I’ve been investing socking money away in my Roth IRA for a couple of decades now and it’s doing well, but without any other income streams, it might be just enough to supplement Social Security in retirement. For years, the maximum was $2,000. Even if that compounds for decades, it’s hard to expect that to provide enough income to retire on.

So how did Thiel get a Roth IRA worth $5 billion dollars while contributing under the maximum of $2,000? According to ProPublica’s information, “Thiel paid $0.001 per [PayPal] share — yes, just a tenth of a penny — for 1.7 million shares. At that price, he was able to buy a large stake for just $1,700.”

Of course, today PayPal is worth a lot more money, so nearly two million shares are worth a lot of money as well. Thiel is also a Silicon Valley insider, so he can invest these gains in other Silicon Valley start-ups. Some have surely failed, but some have become home runs.

So what’s so scandalous? I see two things that are scandalous:

  1. As founder of the company, he could price the shares unreasonably low – which appears to be a tax violation**. The ProPublica article points out that soon after the transaction there were multimillion dollar investments in place. So theoretically, the shares should have been worth maybe $0.25 (pure speculation on my part for sake of example), meaning that he would have “only” been able to buy 8,000 shares with $2,000… quite a big difference than 1.7 million shares. If those 8000 shares became worth $100, he’d have only $800,000 a far cry from $5,000,000,000.
  2. If Thiel didn’t have the Roth IRA tax shelter (or used it how it was meant to be used) the taxes he would have paid on his investment gains could have funded critical infrastructure for many, many Americans.

I like to give people credit for beating the system. However, it’s hard when it looks like “beating the system” appears to be illegal tax manipulation.

How Can You Be Like Thiel

The simple answer is you can’t. ProPublica has a video explaining why:

However, we can use the extreme Thiel case as a guide for what you could do with your own investments. He put in an extremely high-growth asset. Since most money in a Roth IRA is designed to stay there for a number of years, it makes sense to buy in your highest growth investments as well. Typically these would include investments in small companies. For example, I’ll be putting more of my stake of Vanguard Small-Cap ETF (Symbol: VB) in my Roth IRA. Since its 2004 inception, it has gained an average of 10.5% a year.

On the other end of the spectrum, I invest in Vanguard Total Bond Market ETF (Symbol: BND) as well. Since its 2007 inception, it has gained an average of ~4.1% a year.

Let’s see how the two investments strategies work in a Roth IRA vs. a taxable account. If Mary invests $6,000 in VB (and earns the historic 10.5% a year) in a Roth IRA (once and does nothing else), she’ll have $325,568 to withdraw tax-free. If Mary invests $6,000 in BND (and earns the historic 4.1% a year) in a Roth IRA (once and does nothing else), she’ll have $29,935 to withdraw tax-free.

Let’s assume that Mary is in a 25% tax bracket. Mary has $6,000 to invest in both a Roth and a taxable account and puts the high-growth in a Roth, she’ll have both amounts $325,568 and $22,451 ($29,935 after taxes) or nearly $350,000. If she switches where the assets are she’ll have $29,935 tax-free and $244,176 ($325,568 after taxes) or around $275,000. That’s a loss of $75,000 or nearly 20% by simply managing your assets in the most advantageous places.

You might say that this is an extreme example, since it’s 40 years in the future. However, keep in mind that this is a one-time Roth IRA investment, most people will invest many years of their life. It should also be noted that inflation isn’t factored here. However, it would hurt both investments equally, so the example still has integrity… it’s just that the $350,000 and $275,000 won’t buy as much in 2060.

You may want to be even riskier with your Roth IRA and pick satellite stocks. You won’t find a PayPal for a fraction of a cent, but I’ve been able to invest in SNAP and Pinterest and seen those shares grow 5x or 10x what I’ve paid. This is also why I invest my kids’ Roth IRAs in riskier, high-growth assets.

So what do you think? I realize this is largely two articles in one, but I hope it’s got you thinking. Please let me know those thoughts in the comments.

* I should clarify, “First one this year.” In 2019, ProPublica covered how taxes scam everyone, by purposely being complicated to keep the tax preparation industry profitable.

** I’m not a tax expert, so I’m relying on my best interpretation of the ProPublica article and common sense.

ProPublica’s Scandalous Reveal of the Wealthiest People’s Taxes

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There’s been some considerable buzz the last few days around ProPublica’s Tax Revelation. Never before have has an organization obtained the taxes of the richest people in the United States… and then reported on the results in detail.

I want to get to the content of the report itself, but the reporting is scandalous, because it involves a significant invasion of privacy. ProPublica explained why they ahead with the article, explaining that there was a great public benefit to know what’s going on behind the scenes. They also explained that they feel they have significant legal protection since they didn’t solicit the information. In any case, exposing the privacy of people who have a combined wealth of over a trillion dollars takes an amazing amount of courage. When a news organization is going to take that risk, with minimal profit upside, we owe it to them to read the article and pay attention.

What we Learned from the ProPublica Article?

While I just finished saying that we owe it to ProPublica to read the article, it is L-O-N-G. Because of this, I’m going to tell you a little bit about what’s inside and we’ll go from there.

One reason why the article is so long is because it details a lot of the history of taxation in the United States. I never knew that income tax was unconstitutional until the 16th Amendment in 1909. If you think about it, we’ve only had an income tax for a little more than 100 years. Some of the oldest people in the world would have been alive when America didn’t have an income tax.

The main point the article tries to make relies on a little statistical gymnastics. That’s not to say there’s anything false or even misleading about it. It’s just that it shines the light on some math that I’ve never seen combined. Specifically, it highlights how the wealthy are able to grow their wealth exponentially over a number of years and how they can do it while avoiding paying taxes. The average person earns a salary and pays taxes on it right away. This means that they typically build a little wealth through savings over a long time, while paying around the same amount of taxes during that period.

The wealthy don’t have to pay taxes on a lot of their wealth, because they earn it in stock ownership. They don’t pay taxes unless they sell the stock and it gets converted into gains.

In short, they don’t have to pay taxes on wealth, which is very different than income.

It’s important to note that they may have to pay taxes on dividends, but many of the tech billionaires come from companies that don’t pay dividends. When the wealthy do sell the stock, it gets taxed at the long-term capital gains rates, which is 20% for the ultra-wealthy. That’s a much better tax rate than the 37% top income tax rate.

However, and this is perhaps the big revelation, the ultra-rich borrow money from a bank at a low interest using their stock as collateral. Suddenly they are paying 3-5% interest instead of 20% capital gains. The article cited a couple of instances where Larry Ellison had a $10 billion credit line and Elon Musk had the same for more than $55 billion dollars.

This leads to what is known as “Buy, Borrow, Die.”

What is “Buy, Borrow, Die”

The “buy” part, I think is more accurately described as earn or acquire. In this case, it is about growing assets. If you start a successful company you may have a lot of stock. This can happen if you come on a C-level executive as well. You don’t really “buy” the stock, it is earned. In order to “buy”, you’d have to have the income first which would presumably be taxed at that time. In any case, that’s the nomenclature that we inherit and I don’t have the clout to change it.

I covered the “borrow” part above. The last part is to “die.” This is the easiest step because it will inevitably happen anyway. On a serious note, this is about setting up your estate so that you can pass on money to heirs and escape estate taxes and things like that. The ultra-wealthy have some ways of doing this involving hundreds of trusts according to the article. The article also mentions that they avoid taxes by giving money to charities. In my opinion, that’s a greater good than paying more taxes.

ProPublica put together a quick video about how this “Buy, Borrow, Die” strategy works:

If you want to read more about it, my friend, Jim Wang at Wallethacks, wrote about “Buy, Borrow, Die” strategy last November. As usual, he was ahead of the curve.

Create Your Own “Buy, Borrow, Die”

The point of ProPublica publishing this information is to create awareness of the inequity of the tax code. It’s a time when politicians are looking at revamping the tax code so that the ultra-wealthy pay more. How can you use this information? You can talk to your politicians and try to impact tax policy going forward. Unfortunately, that’s a steep uphill climb.

Can someone of more moderate wealth create their own “buy, borrow, and die”? I’m not sure, but I’m intrigued by the idea. I think some people have created something like that with their FIRE plan. Their general plan is to buy stock (or real estate) and let it compound (piggy-backing on the ultra-wealthy stock gains). Then retire to have little income and have that stock throw off dividends that, for some lower-income levels may be completely tax-free. Tools like a Roth IRA and a Roth IRA conversion ladder may also help you effectively pay no taxes.

In the above scenario, the “borrow” doesn’t come into play unless it is based on real estate. The final step of dying and leaving money to heirs is a lot easier for the moderately wealthy. They don’t have to deal with estate taxes. The heirs also enjoy a step-up tax basis for stock assets. This means that the next generation doesn’t have to pay taxes on all the gains.

I should note that there are ethical questions about avoiding taxes. Most of the responses in the ProPublica article come down to, “We’re doing what’s legal. Don’t hate the player, hate the game.” Many also point out that they give so much away that it’s kind of silly to look at the taxes they pay. For example, Warren Buffett has pledged to give away 99.5% of his wealth. How upset can you be with him for legally avoiding taxes with that in place?