The 5 Billion Dollar Roth IRA

Posted By: Chris Tanner ICOR Blog & News ,

Recently, there has been a lot of news about Peter Thiel’s 5 billion-dollar Roth IRA. Google the phrase “Billion Dollar Roth IRA’’ and you will get countless hits to investigate for yourself. It was recently revealed that Peter Thiel’s Roth IRA is valued at over 5 billion dollars. Who is Peter Thiel, and more importantly how did he amass such a large amount of wealth in a retirement account? Peter Thiel is a Stanford Law graduate and is one of the founders of PayPal. In 1999 Peter made a $2,000 contribution to a Roth IRA, which was the maximum allowed at that time. Interestingly, he never made another contribution to his Roth IRA. Shortly after making that $2,000 Roth contribution, Mr. Thiel purchased 1.7 million shares of PayPal for $1,700 using his Roth IRA. The shares were sold to his Roth IRA for o.oo1 per share, or 1/10 of a penny per share. When PayPal later went public at $50/share, Peter hit it big. $50/share x 1.7 million = $85,000,000. Peter followed up with similar investments in Facebook and Palantir before they became publicly traded companies.

Let us evaluate the strategy behind using a Roth IRA to invest in shares of a privately held company. First, a little history on the Roth IRA. In 1997, the late Senator William Roth Jr. championed legislation that created the Roth IRA. The Roth IRA has some unique characteristics, such as contributions are made after they are taxed, and account owners can take out the contributions and earnings TAX FREE as long as they are 59 1/2 and the account has been open for at least 5 years. In addition, the Roth IRA is NOT subject to required minimum distributions. Meaning distributions are BOTH tax free and optional. By using a Roth IRA Peter Thiel will never pay tax on this account, nor will his heirs. What if Mr. Thiel had used a traditional IRA for the exact same investment?

A Traditional IRA allows for tax deferred contributions, but the contributions and earnings are subject to ordinary income when they are distributed or taken out. Distributions are required at the age of 72. That means Peter Thiel would have been subject to Federal income tax, and currently the highest tax bracket is 37%. In addition, he would have been subject to state income tax of 12.3% in California. Said another way, Mr.Thiel would have been paying just under a 50% tax on any distributions from a Traditional IRA. It is clear why Peter Thiel used a Roth IRA, and not a tax deferred retirement account. He can avoid paying a nearly 50% tax on distributions.

This must be illegal, right? How can someone possibly turn $2,000 into $5,000,000,000 in just 22 years? Interestingly, the IRS audited Peter Thiel in 2011 and found no inappropriate or prohibited activities. Truth is, Peter Thiel used a self-directed Roth IRA to invest in private equity which is allowed by the IRS as long as some basic guidelines are met. Nothing Mr. Thiel did was illegal, prohibited, or otherwise outside the IRS code. Peter followed the rules as set by the IRS code. Is Peter Thiel a villain who somehow figured out loopholes in the tax code and cheated the system, or did he play by the rules and leverage his knowledge of the tax code to find the best, most efficient way to invest? You decide! By the way, you have the exact same tool available to you. The self-directed Roth IRA.