Lessons Learned from Billionaires and Their Roth IRAs

This won’t be an easy request, but can we, for a moment, put aside our anger and frustration at the billionaires who used Roth IRAs as their personal tax-free piggy banks? It’s hard not to get upset over a billionaire who managed to put a couple big in a Roth IRA and is now worth more than $ 5 billion, tax-free. For some, this just doesn’t seem right. However, the reason for letting go of anger momentarily is that there is an opportunity to draw some retirement planning lessons from this story of excessive earnings.

When ProPublica revealed the amount of taxes paid by the richest of the rich late last month, a storm of criticism erupted. As the information became more granular and exposed the unimaginable leverage of the popular Roth IRA planning tool, especially by billionaires Peter thiel, the condemnation of some sectors was intensified. We learned that wealthy people could contribute privately owned shares to a Roth IRA, sell the shares when they were worth it in an IPO, reinvest that profit in another private transaction, make even more profit, and achieve it all within one tax. free wrapping. All of this is legal. The money generally enters the Roth IRA through a Roth conversion, the purchase and sale of the pre-IPO securities occurs within the qualifying account, and as long as the investor waits until age 59 ½, the total amount is tax-free. . Just to add a little sweetener to the mix, the account is creditor protected, and once the participant is 59½, there is the option to access the funds tax-free or let them continue to grow. There are no minimum distributions (RMD) required for Roth IRAs.

The numbers are staggering in the cases of these billionaires, but the question is whether there is anything that we, who do not reside in the financial stratosphere, can learn from these stories. Surprisingly, yes, there are lessons to be learned, both positive and negative.

Roth IRAs have tax advantages

Not that Roth IRAs are some kind of tax loophole. They are supposed to be tax free. It could be said that the Size of the earnings allowed for billionaires is not intentional on the part of Congress, but the tax-advantaged nature of the Roth IRA is well known. If you need proof that you can save taxes with a Roth IRA, look no further than how these industry captains have benefited. To review, you can deposit after-tax dollars into a Roth IRA, and those funds not only grow tax-deferred, but are paid tax-free. Once you have owned the account for at least five years and experienced a triggering event (turning 59½, death, disability, etc.), you will have tax-free access to the account. Also, if you still have funds in your Roth IRA when you turn 72, unlike traditional IRAs, you are not required to make minimum distributions. Your retirement account can grow and be left to your heirs as a legacy. The upshot is that a Roth IRA is both a great retirement tool and a useful means of wealth transfer.

Roth conversions enable large transactions

Contributing directly to a Roth IRA greatly limits this benefit to the middle class. The maximum contribution for 2021 is $ 6,000; if you’re 50 or older, it’s $ 7,000, and even that amount is limited if you make too much income. For example, a married couple making $ 208,000 or more will not be able to contribute to a Roth IRA. The magic for the rich and wealthy is the ability to turn a traditional IRA into a Roth IRA. No matter how many zeros there are in your 1040, you can take your traditional tax-deferred IRA, pay taxes on the account, and turn it into a Roth IRA. Several of the stories exposed about billionaires’ accounts involved leveraging an IRA by funding it with privately owned stocks, turning that account into a Roth IRA, and seeing how it was built tax-free. There are simply no limits to this transaction.

Because of this lack of limits, the Roth conversion can be a useful retirement tool for the wealthy. In a previous post this year, I noted that you can lower general taxes by distributing your IRA conversions to Roth IRAs. Roth’s systematic conversion technique helps spread income taxes over several years. In many cases, you can convert just enough from an IRA to your Roth IRA to stay in your same fringe tax bracket. This benefit can be enhanced if the conversion takes place when the value of the underlying investment is depressed. A Roth conversion of IRA shares in March 2020, when the market was recovering from the pandemic, would have moved assets efficiently at a low fiscal cost. This approach is potentially even more powerful today because tax rates are likely to rise.

Looking at the use of IRAs for wealth transfers, the changes brought about by the SECURE Act of 2019 make Roth IRAs even more attractive. Because the Extendable IRA approach no longer applies to most inherited IRA beneficiaries, the Roths offer an after-tax way to limit the tax consequences for adult beneficiaries. Accounts generally must be paid within 10 years of the participant’s death, but with the Roth IRA, the amounts paid are free of income tax. If it’s good enough for people like the billionaires club, your own retirement and estate planning is worth a look.

Your Roth strategy is under your control

Like it or not, the law has included certain tax-favored transactions, and a lesson learned from the rich and famous is that tax planning pays off. Instead of assuming that only the rich can benefit from tax planning, do it yourself. An example of Roth planning is the so-called “Roth 401 (k),” which has become very popular in the world of qualified defined contribution plans. Many employers allow their employees to direct their contributions to a taxable Roth account instead of their regular tax-deferred 401 (k) account. The potential for contribution is greater than with a traditional IRA or a Roth IRA. A 401 (k) involves an annual contribution of $ 19,500 (no income limit) compared to a contribution of $ 6,000 for a Roth IRA. The advantage of this strategy for many is that you pay taxes on the seed (the contribution) but not on the harvest (the account when you retire). If you expect taxes to increase, specifically you taxes to increase, choosing a Roth account in a 401 (k) may reflect, in miniature, what billionaires have done. Combining this with specific Roth conversions, you have the task of strategizing retirement contributions and withdrawals to maximize your tax savings.

Negative lessons learned

If your parents ever asked you, “just because your friends jumped off a bridge, did you?”, You can anticipate my next question. Just because the wealthy aggressively leverage Roth IRAs to secure millions in tax-free earnings on high-growth stocks, should you? The answer is no. A Roth IRA is not a good vehicle to invest in a steering wheel. Aggressive security selection carries the risk of a loss. With a billionaire, that loss can be absorbed in other transactions. With the rest of us, a principal loss is something we could use on our tax return. By buying a stock with a tip and placing it in a Roth IRA, the profit from the sale is protected. But if the possible, even probable, happens and the stock loses, you cannot cancel the loss. More importantly, that means less money available for your retirement.

Another problem is the risk of legal fees. Many of the detailed transactions with the billionaires involved IRS audits, SEC threats, and press exposure. These attacks involve legal expenses that often cannot be justified when the numbers are small. If you are not talking about millions in potential upside earnings, then thousands of professional costs are not worth incurring. Do what is best for you.

You may get angry, envious, or whatever your emotional reaction is to the news that some billionaires have worked in the system with Roth IRAs. In the meantime, however, I suggest that you focus on yourself and your retirement first. There are lessons to be learned about Roth IRAs. Use them, use them.

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