A recent article in ProPublica explored how Peter Thiel turned $2,000 in a self directed IRA into $5 billion tax-free, and you could take a few lessons from this story. Whether you are just starting out in your career or you are nearing retirement, if you do not have your Roth IRA started, you have many reasons to make this your next big financial move.
The Power of the Roth IRA
Peter Thiel might not be as familiar a name as Elon Musk or Jeff Bezos, but you are probably familiar with his company. He is the founder of PayPal. Peter Thiel started his Roth IRA in 1999 with $2,000. Twenty years later, his account was worth $5 billion. By comparison, the Roth IRA account of an average American stands somewhere around $39,108, according to the ProPublica report, so what did you miss?
The Roth IRA was established in 1997 and was named after William Roth, a former Senator from Delaware. A Roth IRA allows you to fund your account with after-tax contributions. You have already paid taxes on it, so when you withdraw it, it is tax-free income. You cannot deduct your contributions, as you can with a traditional IRA, but you will not pay taxes on your withdrawals either.
There are some limits as to who can contribute directly to a Roth, and limits are also placed on how much you can contribute, so how did the ultra-rich amass this amount of money in their account? You can convert a traditional IRA or 401k to a Roth. You will pay taxes on the money converted, but then it can grow tax-free, as long as it is held in the account for at least five years and you are age 59 ½ or older. This still does not explain how Peter Thiel, and other billionaires, amass so much in their accounts.
The Self Directed IRA Loophole
The loophole that the wealthy used is that they used a self-directed IRA. A self-directed IRA has the same income limits and rules as a regular Roth IRA, but you have a wider choice in the investment instruments that you include. The wealthy were able to contribute privately-held stock to their IRA. Then, they sold the stock by paying it off in an IPO. They reinvested the gain. All of this was done tax-free. They also transferred funds from a traditional IRA to a Roth, which allows larger transactions.
Could This Work for You?
This all sounds like a genius plan, and by now, you are probably wondering if this could work for you. The answer is that it depends on your income level. You must meet certain income levels to be allowed to contribute directly to a Roth IRA. If you do qualify, you need to be aware that you must know what you are doing, or you could end up in big trouble with the IRS. There are many rules to this type of account.
The main difference between a self-directed Roth IRA and a regular Roth IRA is the types of investments it can hold. A regular IRA custodian, such as Vanguard and Fidelity, can only hold publicly traded stocks, bonds, mutual funds, and similar instruments. A self-directed IRA allows you to hold real estate, private placements, partnerships, franchises, precious metals, and tax liens. There are some assets that you cannot hold in a self-directed IRA, but you have much more freedom than with a regular Roth.
If you consider yourself a financial expert, you might want to look into a self-directed IRA as an option, but before you dive in, make sure you know all of the rules first. If you break the rules, you can lose all of your wealth in one stroke of the pen by the IRS. This can be an excellent tool for building wealth, but it can also be risky business if you do not know what you are doing.