In 1996, Peter Thiel started PayPal. To date, he arguably has the most famous implementation of a Roth IRA strategy. That same year he placed 1.7 million shares of PayPal into his Roth IRA. At the time the valuation of these shares was $1,700 which allowed him to place all the shares into this tax-sheltered vehicle. We all know PayPal has grown to be worth billions. What you might not know is Thiel's investment has become a tax free compounding machine.
This is a fun story to share around a campfire, but what does this mean for you?
In this blog, we are going to break down what is a Roth IRA and 3 ways you can use one.
What is a Roth IRA?
A Roth IRA is an individual retirement account. The way retirement accounts work is the government provides you with a benefit to incentivize you to save for retirement. A Roth IRA provides a future year tax benefit. When you contribute to a Roth IRA you do not get a tax benefit today but any money in this account grows tax free and gets distributed tax free. Retirement accounts will provide tax benefits but they also have regulations on when you can use the money. In a Roth IRA, you can pull out contributions at any time but the growth of your investments is subject to a 10% penalty should you use the funds before 59.5.
3 Ways to Use a Roth IRA
1) Making an Annual Roth IRA Contribution
Before we talk complex let's keep it simple. The first way and simplest way to contribute to a Roth IRA is to do it directly. Every year you are going to have the option to contribute to a Roth IRA. Let's break down the rules and regulations in order for you to be able to make this contribution.
Earned Income – In order to contribute to a Roth IRA you have to have earned income. This is income you make from performing a job or active income. This CANNOT be portfolio income.
Income Limit – You will also need to make under $230,000 as a married couple to make a full Roth IRA contribution or under $146,000 as a single tax filer. If you make more than this, we have a plan for you to contribute later in this blog.
Funding Limit – Depending on your age you will be able to contribute different amounts of money. If you are under 50 you can contribute $7,000 to your Roth IRA and if you are over 50 you can contribute $8,000 annually. These numbers are for the 2024 calendar year.
If you are married and make under $230,000 as a couple this is the simplest way to start getting money into a Roth IRA and growing it tax free.
2) Backdoor Roth IRA Contribution
For those of you reading this that are over the income limits listed above this section is for you. One strategy we utilize on regularly is a backdoor Roth IRA strategy. Let's break down who is eligible and how it works.
Income Limit – No income limit on making this contribution.
Pro Rata Rule – This is only available to those who DO NOT have any assets in an IRA. If you have assets in an IRA you will be subject to the pro rata rule. This rule will stop you from being able to do a backdoor Roth IRA contribution. The two ways to get around this are to convert your IRA to a Roth IRA or roll your IRA assets into your 401(K). This is a decision you should make in conjunction with your tax professional and financial advisor.
Funding Limit – This funding limit is the same on a backdoor Roth IRA. $7,000 annual contribution if you are under 50 and $8,000 annual contribution if you are over 50.
The Mechanics – To implement this strategy you will need to follow these steps.
1. Put $7,000 into your IRA.
2. Transfer the $7,000 from your IRA to your Roth IRA.
3. Invest your Roth IRA and grow your assets tax free.
This is the most popular strategy we see utilized for families that are making significant income. Over a decade, a couple could get six figures into these tax free vehicles. With steady growth, this could turn into millions of dollars in tax free money.
3) The Peter Thiel Method
This is the most complex way to potentially maximize your Roth IRA. Before you tell me this is what you want to do, know that the conditions have to be right. When you are looking at copying what Thiel did you need to be able to say yes to one of these statements below.
You have stock in a company that is worth less than the annual contribution limit ($7,000) for a Roth IRA. Remember Thiel’s PayPal stock was only worth $1,700 at the time he contributed it to his Roth IRA. This is unique and typically only applies in venture capital scenarios.
You have money in a Roth IRA that I want to invest in high growth private companies. If you didn’t start the company but want to invest tax free you will need funds in a Roth IRA. If you aren’t sure how to do this revert back to reading steps 1 and 2 above.
If you can answer yes to one or both of these scenarios you could potentially execute the holy grail of Roth IRAs. To implement these, we will need to get specialized legal, tax, and custodians in place. All things Moment Private Wealth can help you with.
The reality is most of us will never use a Roth IRA in the way Thiel used it, but that doesn’t mean that the Roth IRA still can’t be a powerful tool. The reality is that steps 1 and 2 could still help you save millions in tax free money.
If you are a pro athlete or entrepreneur who is interested in learning more about how a Roth IRA might fit into your financial plan, schedule a call and talk with a Moment founder.
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*Moment Private Wealth offers information on tax and estate planning that is general in nature. Tax and Legal advice are not provided by Moment Private Wealth. Consult an attorney or tax professional regarding your specific legal or tax situation.
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