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:
- 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.
- 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.