MetroWest Daily News, The (Framingham, MA)
ProPublica’s recently uncovered IRS record mine 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 by holding much of their wealth in investments, which often are not taxed on an annual basis.
The most recent example from the ProPublica report: PayPal co-founder Peter Thiel, who in 1999 had the privilege of buying shares in the company for a tenth of a dime a share. He bought 1.7 million shares for just $ 1,700, and he did so in a powerful retirement account known as a Roth IRA.
The Roth IRA Advantage
It is no coincidence that Thiel opted for a Roth IRA to hold his PayPal shares: investments in a Roth IRA grow tax-free. In Thiel’s case, ProPublica says the investment has reached around $ 5 billion.
Yes, that seems unfair. But typical Americans don’t have to be Peter Thiel to reap the Roth tax benefits.
âThe rules aren’t much different for Peter, or any wealthy person, and the average person out there,â says Todd Scorzafava, certified financial planner and partner at Eagle Rock Wealth Management in East Hanover, New Jersey.
So what are these rules? Among other things, you will have to wait until age 59 1/2 to start withdrawing investment income from your Roth IRA; otherwise, it may be taxed or penalized. The account also has income limits and an annual contribution limit of $ 6,000 ($ 7,000 if you are 50 or older). Those who follow the rules – tech billionaires or otherwise – reap the rewards of the Roth.
How Anyone Could Benefit From a Roth IRA
With a traditional IRA, contributions are tax deductible, which means your taxable income will be lower in the year you make contributions. However, distributions at retirement are taxed as ordinary income.
Roth IRAs are funded with money that has already been taxed, so there is no additional tax deduction on contributions. But withdrawals eligible for retirement are tax free. This makes Roth IRAs a particularly attractive option for long-term savers, says Scorzafava.
“Yes, a tax deduction now sometimes seems fine, but will that tax deduction outweigh a Roth’s benefit later?” said Scorzafava.
Think of it this way: At the start and middle of your career, you will likely be in a lower tax bracket. So it may make sense, says Scorzafava, to contribute to a Roth early on. Ideally, your investment will increase over time and you will be able to withdraw money in retirement tax-free.
A place for high-growth assets
PayPal 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 timeline – looking at you, 20-30 year old investors – can still use their Roths as a pen for aggressive, high-growth investments.
âWhere you put your assets can make a big difference,â says Scorzafava.
A diversified portfolio typically includes a mix of stocks and bonds: stocks are higher risk assets that often generate higher returns; bonds are low yield buoys that can help reduce volatility. However, young investors with decades before retirement may want to stack their portfolios with primarily, if not entirely, stocks and mutual funds. A Roth IRA can be a perfect place to park them.
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