Back in 1999, Peter Thiel was a Stanford graduate and entrepreneur who ran a small hedge fund with a relatively small stake in what would become the leader in online payments. As chairman and CEO of this fledgling startup, he made an annual salary of $73,263, well under the $110,000 maximum earnings allowable to contribute to one of the recently created Roth IRAs, which had a maximum contribution limit of $2,000.
Thiel’s online internet startup company, PayPal, like many other startups, paid its founders relatively meager salaries coupled with large stock grants. Thiel’s initial purchase of founders’ shares was 1.7 million shares at $.0001 per share, or $1,700, well under the $2,000. However, what made this purchase unique at the time was he did it through his newly formed Roth IRA. That $2,000 contribution was the last he ever made to his Roth IRA.
Thiel’s modest bet on his new company paid off handsomely. In just a year, Thiel’s PayPal stock would be valued at $3.8 million. By 2002, PayPal was acquired by eBay, and Thiel’s initial $1,700 investment was now worth $28.5 million. All tax free. Had these shares existed outside his Roth IRA, he would have owed 29% to the federal and California tax authorities. In other words, utilizing the Roth had already saved him $8.265 million! But that was just the beginning. He could now use that money to purchase or sell nearly any investment he wanted, entirely tax free.
In 2003 he founded data analytics company, Palantir, along with a CIA-backed venture fund. Later, in 2004, Thiel met Mark Zuckerberg and invested $500,000 in Facebook, also using the funds in his Roth. By the end of 2008 Thiel’s Roth had ridden Facebook’s meteoric rise to a total valuation of $870 million.
Today his Roth IRA is worth more than $5 billion. The taxes avoided amount to more than $1.4 billion! This column is not to suggest you can amass $5 billion. But it is designed to illustrate the power of a Roth. All of the growth, including long- and short-term capital gains are tax free. Upon his death, he will be able to pass it along to his heirs, free of MRD or capital gains taxes, although it will still be subject to estate and inheritance taxes.
A great way to leverage the Roth for estate planning is to convert as much as you can of your traditional IRA into a Roth. There is no limit on what you can convert; you just must pay ordinary income tax. Doing so removes any future income taxes for you as well as reduce the size of your estate. Even though the Roth must be depleted within 10 years after your death for non-spousal beneficiaries, there will be no tax consequences for doing so, as all the income taxes due have been met through the conversion.
The bottom line is the more you can convert and grow your investments inside a Roth, the better off you, and those who follow you, will be.
Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, NH, he services Greater Boston and the New England areas.