A plethora of IRS data recently revealed by ProPublica has confirmed what many have always suspected: billionaires often enjoy a significantly lower tax rate than the average American.
They do this by claiming losses and deductions that reduce their taxable income and keep most of their wealth in investments, which are often not taxed annually.
The latest example from a ProPublica report: PayPal co-founder Peter Thiel, who in 1999 had the privilege of buying company shares for one-tenth of a pence per share. He bought 1.7 million shares for just $ 1,700, and he did so in a retirement account known as the Roth IRA.
The advantage of the Roth IRA
It’s no coincidence that Thiel opted for the Roth IRA to hold its PayPal shares: Investments in the Roth IRA are growing tax-free. In Thiel’s case, ProPublica says the investment has grown to about $ 5 billion.
Yes, that seems unfair. But typical Americans don’t have to be Peter Thiel to take advantage of Roth’s tax breaks.
“The rules are really no different for Peter or any wealthier person and the average person out there,” says Todd Scorzafava, a certified financial planner and partner at Eagle Rock Wealth Management in East Hanover, New Jersey.
So what are those rules? Among other things, you will have to wait 59.5 years to start extracting investment income from your Roth IRA; otherwise, it may be taxed or punished. The account also has an income limit and an annual contribution limit of $ 6,000 ($ 7,000 if you are 50 or older). Those who follow the rules – technology billionaires or otherwise – reap the Roth Prize.
Everyone can benefit
With a traditional IRA, contributions are tax deductible, which means your taxable income will be lower in the year you pay your contributions. Retired distributions, however, are taxed as ordinary income.
Roth IRAs are funded by money that has already been taxed, so there is no additional contribution tax deduction. But withdrawn retirements are tax-free. This makes the Roth IRA a particularly attractive option for savers with a long-term horizon, Scorzafava says.
“Yes, the tax deduction now sounds great now, but will that tax deduction later outweigh Roth’s benefit?” Scorzafava says.
Think of it this way: In the early and middle stages of your career, you are likely to be in the lower tax bracket. So maybe it makes sense, Scorzafava says, to contribute to Roth early. Ideally, your investment will grow over time, and you can withdraw your money in retirement without taxes.
High growth assets
PayPal’s shares in Thiel’s Roth IRA have grown in a way most of us will never see in our own Roths. However, anyone with a long investment timeframe – looking at you, investors in their 20s and 30s – can still use their Roths as a pen for aggressive, high-growth investments.
“Where you place your property can be a profound difference,” Scorzafava says. “Where would you like to own a high-growth company? I would like to own it in my Roth IRA first, because the return expectations should be higher, and it will grow up tax-free. “
A diversified portfolio usually involves a combination of stocks and bonds: stocks are riskier assets that often lead to higher returns; bonds are lower yield buoys that can help reduce volatility. However, young investors who for decades until retirement may have wanted to put their portfolio together mostly – if not entirely – in stocks and mutual funds. The Roth IRA may be the perfect place to park them.
By opening up and investing through the Roth IRA, you grow your wealth over time. Your account balance may not have as many zeros as Thiel’s, but the mechanism for accumulating your own wealth is the same. Then, when you retire, you can take advantage of that accumulated wealth, which means that at least part of your income will remain untaxed – just like some of the richest people in the world.
Too rich for Roth?
There is one major catch with the Roth IRA: revenue constraints. In 2021, you cannot contribute if you earn more than $ 140,000 as an individual or $ 208,000 if you are married together.
But Scorzafava says you can still take advantage of Roth if your income exceeds that threshold. There are perfectly legal ways for those earning more to take advantage of Roth’s tax benefits; The most common is the backdoor Roth IRA, which requires converting a traditional IRA into a Roth account. It is best to be guided through this process by a financial advisor, says Scorzafava.
Your wealth will most likely never coincide with the wealth of Peter Thiel, but there is no reason not to take similar steps to reduce the tax on the money you accumulate.