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Overstuffed

Back in 1997, Delaware Senator Bill Roth sponsored a new kind of retirement savings account with a back-end benefit. In contrast to traditional IRAs, which let you deduct your contributions and defer tax until you pull money out, the Roth IRA lets you contribute after-tax dollars in exchange for tax-free withdrawals. Roth designed his new account to help “hard-working, middle-class Americans” save. So there was a $2,000/year contribution limit. And you could convert a regular IRA into a Roth by paying the tax on your balance, but only if your income was under $100,000.

Since then, contribution limits have gone up to $6,000 — $7,000 if you’re over 50. And anyone can convert an existing IRA to a Roth, as long as paying the tax makes sense (which we can help you evaluate). Today’s proactive planners have discovered even better ways to work around the statutory limits, including something dubbed a “Mega Backdoor Roth IRA.” (That sounds almost dirty, doesn’t it?) But nobody was ready for last week’s news that tech titan Peter Thiel had stuffed $5 billion into his Roth.

So, how exactly do you turn $2,000 into $5 billion — tax-free — without selling your soul to the devil? Well, there may be more than just luck and investing genius at work. In 1999, Thiel’s Roth bought 1.7 million shares in PayPal for just one-tenth of a penny each. Three years later, eBay bought that stake — tax-free. Thiel used the proceeds to invest in more lightning-in-a-bottle startups, including Palantir and Facebook. Today, he manages 96 separate Roth subaccounts from a family office across the street from a Cheesecake Factory in Las Vegas.
The story raises the obvious question whether $1,700 is a reasonable price for a founder’s stake in a company that would go on to become worth $357 billion. (Odds are good that you’ve paid more than 1700 bucks for a used car.) IRS rules prevent founders from “stuffing” undervalued assets in IRAs to avoid contribution limits, with penalties that could include paying tax on the entire balance.

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Back in 1997, Delaware Senator Bill Roth sponsored a new kind of retirement savings account with a back-end benefit. In contrast to traditional IRAs, which let you deduct your contributions and defer tax until you pull money out, the Roth IRA lets you contribute after-tax dollars in exchange for tax-free withdrawals. Roth designed his new account to help “hard-working, middle-class Americans” save. So there was a $2,000/year contribution limit. And you could convert a regular IRA into a Roth by paying the tax on your balance, but only if your income was under $100,000.

Since then, contribution limits have gone up to $6,000 — $7,000 if you’re over 50. And anyone can convert an existing IRA to a Roth, as long as paying the tax makes sense (which we can help you evaluate). Today’s proactive planners have discovered even better ways to work around the statutory limits, including something dubbed a “Mega Backdoor Roth IRA.” (That sounds almost dirty, doesn’t it?) But nobody was ready for last week’s news that tech titan Peter Thiel had stuffed $5 billion into his Roth.

So, how exactly do you turn $2,000 into $5 billion — tax-free — without selling your soul to the devil? Well, there may be more than just luck and investing genius at work. In 1999, Thiel’s Roth bought 1.7 million shares in PayPal for just one-tenth of a penny each. Three years later, eBay bought that stake — tax-free. Thiel used the proceeds to invest in more lightning-in-a-bottle startups, including Palantir and Facebook. Today, he manages 96 separate Roth subaccounts from a family office across the street from a Cheesecake Factory in Las Vegas.

The story raises the obvious question of whether $1,700 is a reasonable price for a founder’s stake in a company that would go on to become worth $357 billion. (Odds are good that you’ve paid more than 1700 bucks for a used car.) IRS rules prevent founders from “stuffing” undervalued assets in IRAs to avoid contribution limits, with penalties that could include paying tax on the entire balance.

Tax Beat is a weekly column with a unique angle: making taxes entertaining. Every week Ed explores the humorous aspects of taxes and current events. 

Edward Lyon

Edward Lyon

Edward A. Lyon is CEO of the Tax Master Network, where he's coached tax professionals to add planning and financial services to their business since 2005. Go here to join the network. Go here to upgrade your membership or discuss opportunities in financial services.
Edward Lyon

Edward Lyon

Edward A. Lyon is CEO of the Tax Master Network, where he's coached tax professionals to add planning and financial services to their business since 2005. Go here to join the network. Go here to upgrade your membership or discuss opportunities in financial services.

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