The goal of 401(k)s and Individual Retirement Accounts (IRAs) was always to give the lower and middle class a way to save a nest egg for the future. Yet, Congress is concerned there are loopholes allowing the ultra-wealthy to exploit these tax shelters.
For instance, PayPal Cofounder Peter Thiel has amassed a $5 Billion tax-free Roth Individual Retirement Account, despite limits to annual contributions.
How Did Peter Thiel Grow His IRA To $5 Billion in 20 Years?
If you have an IRA or have looked into getting one, you might well be aware that, as of 2021, you could only put a maximum of $6,000 (under 50) or $7,000 (50+) into an IRA every year. Over two decades, that would amount to $120,000 – $140,000. So how did Peter Thiel end up with $5 billion?
Back in 1999, the Clinton administration blocked Americans making over $110,000 per year from using the tax-free accounts and capped annual contributions at $2,000. Thiel was running a months-old startup venture, earning a modest $73,263 salary that came with a large stock grant. He bought a stake in PayPal with 1.7 million shares at $0.001 per share. Within a year, the value of Thiel’s Roth had shot up from $1,664 to $3.8 million. He made other savvy investments in Facebook and Palantir Technologies Inc that made him a billionaire.
A decade after the Roth was created, the Congress under President George W. Bush allowed a limitless “backdoor” Roth conversion of traditional IRAs to Roth accounts, regardless of one’s income. The option was created as a short-term way to raise tax revenue. Investors had to pay income tax at conversion time, but they’d benefit from tax-free growth and distribution. Investment gains in Roth IRAs are never taxed and Thiel won’t have to pay taxes when he takes the money out, as long as he waits until he is 59.5 years old to withdraw.
Peter Thiel is one of many wealthy Americans who have employed this strategy and amassed tremendous Roth IRAs, including: Warren Buffet ($20.2 million) and Ted Weschler ($264.4 million) of Berkshire Hathaway, and Hedge Fund Managers Randall Smith ($252.6 million) and Robert Mercer ($31.5 million). Three other PayPal execs had IRAs worth more than $80 million each, according to ProPublica.
How Can Middle Class Earners Save for Retirement?
Not everyone will be so lucky with investments as Thiel, but knowing how to get the most out of your investments and retirement accounts is essential to building long-term wealth. Starting with the basics, Americans earning less than $140,000 a year can open a Roth IRA worth $6,000 – $7,000 a year. The money is considered taxable income when you put it into the account, but you can withdraw the money without penalty starting at age 59.5. Early withdrawals are subject to a 10% penalty.
Most traditional brokers restrict investments to publicly traded stocks, bonds, and mutual funds. While these returns can be strong (at 5-30% a year), some investors prefer to build a more diverse portfolio mix, investing in private company shares and high-value assets. One could easily turn $240,000 into more than $1 million over a 40-year period with a modest 7% rate of return.
If you want to invest a greater sum, you can open a 401(k) account. In 2022, you can set aside up to $20,500 in a 401(k). If you are an entrepreneur, you can contribute up to $61,000 as both employer/employee. An additional $6,500 is allowed in catchup contributions for plan participants over 50. Accounts can be set up as traditional 401(k) for tax advantage now — or a Roth 401(k), including a Roth Solo 401(k) — for tax-free withdrawals later. Like a Roth IRA, a Mega Backdoor Roth 401(k) is a way to convert limitless funds into a legal tax-free saving vehicle.
Ubiquity provides low-cost, easy-to-manage small business 401(k)s to employers with less than 100 employees, and entrepreneurs. We help you choose and set up a retirement savings plan. You can use any broker you like for your investments. We’ll handle the administration of the accounts for one low, flat monthly fee, no matter how big your plan grows. Contact us for details.
