No, you probably can’t use your Roth IRA as a massive tax shelter

Recently, the nonprofit newsroom ProPublica reported on how billionaire Peter Thiel, co-founder of PayPal and all-around tech investor, started with a Roth IRA worth $2,000 and built it into a $5 billion tax-free retirement account over the course of 20 years. Other billionaires have done it, too.

Should you be trying to do the same?

Probably not. According to ProPublica, Thiel funded his Roth IRA with money he got from sweetheart stock deals. Most people don’t have access to those deals, so they simply don’t have the ability to use a Roth IRA as a massive tax shelter.

Congress authorized the Roth IRA in 1997 in an effort to encourage middle-class Americans to save for retirement. They work by allowing you to take after-tax money and put it into the Roth, where it waits until you reach retirement age. The contributions are not tax-deductible, but you don’t have to pay any taxes on the gains as long as you wait until age 59-1/2 to take withdrawals.

There are rules and limits on the Roth IRA. Since it’s intended for middle-class Americans, you’re not supposed to be able to contribute to one if you make too much money. This year, for example, singles can’t contribute if they make $140,000 or more – the limit for married couples is $208,000.

Moreover, there is a limit on how much you can contribute each year depending on your age. This year, people can’t contribute more than $6,000 unless they’re 50 or older, in which case they can contribute $7,000.

The average Roth IRA account in 2018 held $39,108.

What Peter Thiel appears to have done is make his contributions in startup stock that had the potential to skyrocket in value. He bought large numbers of these shares at a fraction of a penny per share. Then, he just waited until the gains came rolling in. Those gains, no matter how large, are shielded from taxation as long as Thiel waits until 59-1/2 to start taking distributions.

According to ProPublica, Thiel appears to have overcome the income limit by using a one-time shift Congress allowed. It gave everyone – regardless of income – the opportunity to take money they had invested in less-favorable retirement accounts and transfer it into a Roth IRA, as long as they paid a one-time tax.

It’s true that other billionaires have taken advantage of the Roth IRA to build tax-free fortunes. In each case, however, it was because they had access to cheap shares in promising startups, and most people don’t. And, Congress is working to crack down on this tax shelter.

For practical asset planning tips, talk to your business lawyer.