Peter Thiel's tax-free retirement account is nothing new to Wall Street but the sheer scale of his exploitation will lead to calls to close the loophole and windfall last-minute business for custodians that can handle private equity.
Remember Mitt Romney's $20 million IRA stuffed with private equity shares that were practically worthless from a contribution standpoint and appreciated enormously once they were safe in the tax-advantaged structure?
Peter Thiel took that approach a few steps further by parking shares of then-private startup PayPal in his Roth IRA, paying a minimal tax because the stock was effectively worthless at the time. After that, under the rules designed to encourage retirement saving, all appreciation happened outside IRS reach.
When you're looking at 1.7 million pre-IPO shares, that appreciation adds up fast. Thiel actively managed the account, selling some stock to fund his early-stage investments in companies like Facebook and Palantir.
There's approximately $5 billion in that account now. He could keep buying and selling for the rest of his life and the IRS will never get a dime in capital gains tax.
All you need to follow in his footprints is access to low-valued private equity with the potential to be worth more . . . and an IRA custodian that can handle something more than public securities and cash.
Remember, most banks and brokerage firms simply lack the resources or will to work with private equity when they can stuff client portfolios with generic stocks and bonds – or better yet from their perspective, products developed for internal sale.
Bringing a privately held business into an IRA multiplies the complexity in terms of reporting and compliance, leaving this option exclusively to investors who can find a trust company willing and able to accept the burden.
The potential benefits to our sophisticated clientele are simply too profound to do anything else. And that's probably the weak link regulators will try to break if they get serious about closing this loophole.
Retirement is good, right?
When we did retirement policy work in the now-hazy "privatize Social Security" era, the golden rule was that means testing participation was too risky to contemplate. Rich people don't need an incentive to save a few thousand dollars a year . . . but preventing them from doing it is a sure way to alienate the people who pay lobbyists.
As a result, firebrands in Congress can talk a good game about setting income limits on Roth eligibility but it's dead on arrival if it ever comes to a vote. Nobody wants to weaken the IRA framework for mass retail investment.
If anything, people who care about defined contribution tax breaks are more interested in letting households park more money in these accounts. I have to say that in an inflationary environment, $5,500 a year isn't going to stretch far for anyone when the distribution phase starts.
And while it definitely won't stretch far for billionaires, everyone likes an entitlement a little better when they get to enjoy it too. The problem is when billionaires figure out how to structure their payments into the accounts to satisfy the contribution limits and then deliver exponential growth from there.
To be honest, that's not technically a problem either. If a retail investor picks the right stocks or rides the right index funds, $5,500 a year can turn into millions over a lifetime. There's no call to prevent that from happening.
There wasn't even a lot of interest in cutting the loophole when Mitt Romney's disclosures brought it to light. The gains were a little large but he was also a highly compensated manager so the IRA only reflected a portion of his overall wealth.
It's only now that the numbers are rising into the billions that people are concerned. My guess is that they'll go after the private equity contributions. The easiest way to do that is to lean on the custodians to narrow what counts as a viable self-directed IRA asset class.
To be fair, that stuff probably needs updated anyway. But I'd argue that the list needs to be expanded and not reduced . . . or at least we need to have a careful conversation about whether things like digital assets (crypto) count.
Will Congress come for the custodians? Possibly. Is that a good thing or even a cunning thing? Not really. Private equity is where a lot of household wealth comes from. It's the family business. It's the family farm.
It's the start-up in the family garage that creates Silicon Valley fortunes. Parking some of that entrepreneurial equity in a tax-advantaged account isn't evil.
Don't let your IRA be your own boss
Of course, you can't put shares of the family business in your IRA. If the company pays your salary and employee benefits, you've got to keep it at arm's length.
Thiel seems to avoided that problem by using his account as a personal venture capital fund, picking outside opportunities. He was just an investor, not the boss.
And you can't go after him for having most of his reported $7 billion in wealth in the tax-free account. Most middle-class households are in a similar position, so forcing them to only keep a sliver of their net worth in the retirement accounts would be political suicide.
Either way, with taxes going up, tax breaks get more valuable. Any threat of tighter regulations will trigger urgent conversations with clients, just in case.
Vast amounts of private equity is on the move right now anyway. These aren't start-ups. These are established entrepreneurial businesses, sometimes built up for generations.
I doubt outside investors got the idea of parking their stakes in retirement accounts. If they did, they deserve the magnitude of their tax break.
It's too late for most angel investors in successful companies. Their shares may not be publicly traded, but they're still worth something today. Contribution limits apply.
Carried capital gains would also apply if they go the Roth direction. Even if you can only contribute a few thousand dollars worth of stock, a Thiel style basis near zero means capital gains.
For a billionaire, a few hundred dollars in tax to capture the Roth advantage isn't even a rounding error.
And there's no RMD on Roths. Thiel doesn't have any kids, but that's a problem for his estate to worry about.