HOW THE RICH GET RICHER #3
Note: If you find my posts too long or too dense to read on occasion, please just read the bolded portions. They present the key points I’m making and the most important information I’m sharing.
The Internal Revenue Service’s webpage on Individual Retirement Accounts (IRAs) says, “IRAs allow you to make tax-deferred investments to provide financial security when you retire.” However, they allow the wealthy to do much more.
When IRAs were first created in 1974 and then expanded to all workers in 1981, the goal was to encourage saving for retirement by offering a tax incentive, given that Americans were notoriously bad at saving. Initially, the maximum annual contribution was $2,000. It’s now $6,000 or $7,000 if one is over 50. The contribution can be deducted from one’s income, so it isn’t taxed up-front. Tax on the increased value of the investments in the IRA is deferred until the money is removed from the IRA. Money had to be taken out of the IRA starting at 70 ½ years of age (now 72) at a rate the would be expected to deplete it within the lifespan of the owner of the IRA. All earnings and any contributions that had been deducted from income up-front are subject to income tax, which for most taxpayers will probably be at a low rate due to lower income in retirement than when working. This all made good sense and was good policy.
Then came the Roth IRA in 1997. Contribution limits were the same as for the traditional IRA, but the contributions were subject to income tax up-front. However, when money is taken out of a Roth IRA there is NO income tax due on the increased value of investments nor on the contributions. There also is no requirement that money be taken out in one’s lifetime.
The wealthy and their tax / financial advisers quickly recognized that this was a huge opportunity for tax avoidance. It’s clear that some policy makers were aware of this and had no problem with it; in some cases, it may have been their intent. As a further example of how tax policy in general and Roth IRA policies specifically favor the wealthy, if a U.S. citizen renounces their citizenship they are taxed on the value of their assets, including ones that have increased in value even if they have not been sold. However, there are exemptions from the tax for certain kinds of assets, one of which is assets in a Roth IRA! [1]
ProPublica’s investigative reporting on how the wealthy pay very little in income taxes, perfectly legally, while their wealth is growing by leaps and bounds, [2] has also revealed how extensively Roth IRAs are being used for tax avoidance. Their reporting reveals that, among others, investors Warren Buffett and Ted Wechsler of the Berkshire Hathaway fund, Randall Smith of the Alden Capital hedge fund, Robert Mercer of the Renaissance Technologies hedge fund, and Peter Thiel and Max Levchin of PayPal all have Roth IRAs with hundreds of millions of dollars in them. [3]
Clearly, these mega-million-dollar Roth IRAs have nothing to do with saving for retirement and everything to do with avoiding taxes. Thiel has $5 billion in his Roth IRA. He and all the others will pay NO taxes on any money they take out of their Roth IRAs. Keep in mind that these huge IRA balances have supposedly come from contributions of a few thousand dollars a year. The huge gains on the investment of those small contributions will be subject to NO income (or other) tax when they are removed from the Roth IRAs. By the way, Thiel renounced his U.S. citizenship in 2011, allowing him to take advantage of this exemption from taxation for Roth IRA assets. (He became a citizen of New Zealand, which happens to have no estate tax.)
Recognition of the abuse of Roth IRAs for tax avoidance is not new. Forbes magazine and others have written about it since at least 2012. Senator Wyden proposed legislation to reform Roth IRAs in 2016, but it went nowhere in the Republican-controlled Senate. Simple policy changes could address the problem. For example, the dollar amount of investment gains in Roth IRAs that are exempt from taxation could be limited, to say a few million dollars. And the exemption of these gains from taxation could end when the account owner dies instead of allowing them to be passed on tax-free to heirs. [4]
One strategy for creating huge IRA balances is to put knowingly under-valued assets into them. When Thiel contributed 1.7 million shares of the company that would become PayPal into his Roth IRA in 1999, he claimed that they were only worth one-tenth of a cent per share ($0.001 per share). (They were not publicly traded at the time so a fair market value was subject to interpretation.) This meant that his contribution was under the $2,000 limit in place at the time. PayPal later admitted that this per share value was “below market value.” The shares are now worth billions.
Senator Wyden’s 2016 Roth IRA reform proposal would have addressed the problem of under-valuing assets contributed to an IRA by removing the tax exemption of any IRA that received an asset for less than fair market value. Others have proposed requiring IRAs to only receive assets that are traded on a public market so their true value is clearly established.
The financial industry opposes reforms to Roth IRAs because they make significant money from them by acting as custodians for IRAs (and other retirement accounts) and by processing the transactions that these accounts generate.
The IRA was originally designed to enhance the retirement security of working Americans, but it has become another way for the wealthy to avoid paying taxes, even when passing their wealth on to their heirs. Note that there are other types of retirement savings vehicles that also provide tax avoidance and other benefits to the wealthy. “Retirement” savings policies are one example of how the wealthy have gotten elected policy makers to tip the economic playing field in their favor. This is oligarchy in America. (Oligarchy “refers to a government of and by a few exceedingly rich people or families who control the major institutions of society and therefore have power … no one should be fooled. Oligarchs wield power for their own benefit” as Robert Reich writes in his latest book, The System: Who rigged it, how we fix it. (See my previous posts summarizing the book starting here.)
I urge you to contact your U.S. Representative and Senators and to ask them to support reforms that would end the abuse of retirement savings accounts by the wealthy. You can find contact information for your U.S. Representative at http://www.house.gov/representatives/find/ and for your U.S. Senators at http://www.senate.gov/general/contact_information/senators_cfm.cfm.
Please also contact President Biden and ask him to support reform of retirement savings accounts. You can email President Biden via http://www.whitehouse.gov/contact/submit-questions-and-comments or you can call the White House comment line at 202-456-1111 or the switchboard at 202-456-1414.
[1] Elliott, J., Callahan, P., & Bandler, J. 6/25/21, “The ultrawealthy have hijacked Roth IRAs. The Senate Finance Chair is eyeing a crackdown,” ProPublica (https://www.propublica.org/article/the-ultrawealthy-have-hijacked-roth-iras-the-senate-finance-chair-is-eyeing-a-crackdown)
[2] Eisinger, J., Ernsthausen, J., & Kiel, P. 6/8/21, “The secret IRS files: Trove of never-before-seen records reveal how the wealthiest avoid income tax,” ProPublica (https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax)
[3] Lord, B., 6/29/21, “Peter Thiel will pay zero in federal income tax on his $5 billion in gains,” Common Dreams (https://www.commondreams.org/views/2021/06/29/peter-thiel-will-pay-zero-federal-income-tax-his-5-billion-gains)
[4] Elliott et al., 6/25/21, see above