A few months ago, tech and finance circles were buzzing about a move by billionaire Peter Thiel in which he placed some private shares of a tech company in his Roth IRA in 1999 which were then worth $2000. Now the value of those shares has ballooned to $5 billion and at 53, he would only have six and a half more years until he could tap those funds with no tax consequences at all.

Roth IRA’s we’re intended to be investment vehicles for the lower middle and working class. With a small contribution limit at $6,000 as of 2021 and an income limit that is currently at $140,000 for an individual and $208,000 for a married couple, it was not intended as a way for the wealthy to shield themselves from capital gains taxes. The hypothetical example was a moderate income earning person who maybe didn’t have enough in their 401(k) or didn’t have a 401(k) option at their job at all. The IRA and the Roth IRA offered those people options to still save for retirement and still have a nest egg with either no taxes to be paid (for a Roth) or taxes deferred until they are retired (traditional IRA).

The facts show that this is mostly who uses the IRA structure as well. The average IRA balance is $115,400 in 2019 while the average 401(k) balance is $112,300. Social media dispersion of retirement information as well as a buoyant stock market have helped grow those balances from pervious years. The median figures are usually lower because of outliers like Mr. Thiel that skew the average figures upwards.

Yet Thiel tapped into an option for IRA accounts that is little known to most of the public: the self directed IRA. These accounts are traditional or Roth IRA’s that are opened for the purpose of buying private market securities. While most of us open our IRA’s through a traditional provider like Fidelity of Vanguard and buy public securities such as stocks and bonds which are widely available, self directed IRA’s enable the owners to buy shares of private companies that are not on the market, shares in a closely held company the owner may have started or real estate for investment purposes.

Self directed IRA’s (SDIRA’s) tend to be offered by specialized financial companies you may not have heard of. They include Equity Trust, uDirect IRA and The Entrust Group. These companies offer advice, brokerage services and custodial services for the shares that you want to put into your self directed IRA. They advise those who want to set up these structures on how to properly document everything and avoid tax issues if the owners were to be audited.

Restrictions on Self Directed IRA’s

The current format is not a free for all. The reason investors want to open an SDIRA is the diversification and potential for higher returns of private market and less liquid securities. The IRS is well aware of the potential to use SDIRA’s as a vehicle for profits now as opposed to when you retire so they have created some rules regarding self dealing.

There are a few specific types of investments your self-directed IRA cannot hold, as decided by the

These are:

• Life Insurance
• Collectables, like coins, art, and antiques
• S-Corporations (Trusts that qualify as an IRA are not eligible to be members of an S-Corporation)

In addition, transactions that are considered “self dealing” are prohibited. The website iraresources.com provides some examples on what is prohibited.

• You or any disqualified person may not use or live in any property held in your IRA— even if you have partial personal ownership. If this is your goal, the property must be fully distributed beforehand. Our blog on distributing real estate from your self-directed IRA can outline this process for you.
• You can’t use any IRA asset for personal benefit in any way— though most common with real estate, any sort of business or benefit to yourself is considered “self-dealing” and is not allowed with assets held within a self-directed IRA.
• You cannot do any business with any disqualified person (including yourself). If you own a plumbing business, you can’t have your team work on your IRA-owned rental property.
• You cannot pay yourself for any work you do on behalf of the IRA. If you’re a real estate agent, you may act as your own agent while selling the home, but you cannot take commission. If you manage your own properties or LLC, you cannot pay yourself for this either.
• You cannot personally do any work on the asset (known as “sweat equity”). This is because the IRS sees your labor as value-added to the property that you otherwise would have had to pay for, which is not allowed within an IRA.

Self dealing means you cannot transact with a non qualified person. Here again, iraresources.com is helpful on defining what that is.

A Disqualified Person is:

• You
• Your spouse
• Any of your lineal ascendants or descendants (parents, children, grandchildren, and the spouses of children, grandchildren, etc.— including legally adopted children)
• Any investment providers or fiduciaries of the IRA
• Any entity (a corporation, LLC, trust, etc) where a disqualified person owns more than 50%
• Any entity (like previously listed) where the IRA account-holder is an officer, director, a 10% or more shareholder, or a highly compensated employee.

This sounds like you won’t be able to just form a corporation with some likeminded friends and buy up property, yet in reality, the rules above only mean you need about 11 people, each with a 9.09% interest, to chip in via their self directed IRA and you all can buy a property and have someone manage it. This is why many of those same self directed IRA custodians promote networking events for their clients to be able to meet each other and go into business together.

The Current Bill in Congress

To some this may sound like the rich getting together to conspire on gaming the system and becoming richer. If you hate money and you hate people becoming wealthy by playing by the rules then maybe a socialist paradise and police state is a better place for you. The reality is that those that know the rules well will always have an advantage over those who remain ignorant. Defense attorneys often say know your rights or you have no rights. It’s hard enough to get regular people just to save for retirement, if someone is willing to do a deep dive and go way beyond what most do with their retirement funds to get a higher return they should be allowed to.

Because of Thiel’s long shot investment paying off and avoiding billions in taxes, the current bill in Congress is drafted to limit IRA’s to only hold public securities. To pass this new rule would be a pity because it denies the ability for regular people who aren’t billionaires another avenue to participate in private markets and all the advantages they bring.

It would also eliminate the famous “back door Roth IRA” option which allows people to covert a portion of their traditional IRA to a Roth IRA as long as they pay the taxes on the funds. For many people, this allows them to covert funds to a Roth IRA in years when they may be unemployed or not making as much, providing them the potential for more money in retirement, which is a goal that most politicians can get on board with.

In addition, it isn’t clear whether other self directed options would also be eliminated or whether just IRA’s are being singled out. Currently, health savings accounts (HSA) as well as educational savings accounts (ESA), which also have tax advantages, are able to be self directed and purchase private securities. To just single out IRA’s because of Thiel and a news story seems like it would just further the cement the wealthy in their position as they could simply switch the funds to an HSA or ESA to buy their private securities and make billions tax free. It also seems short sighted to limit all account holders simply because one single person was able to bear the system.

This is the same fodder that the right uses to eliminate welfare and social spending programs. Just because one person was able to game the system and receive benefits with no intention of ever working, doesn’t mean that the whole system doesn’t benefit hundreds of thousands of other people and should be tossed in the bin. Practical and well thought out policy should take precedence over covering the asses of politicians pressured because their constituents read a news story. Potentially capping the benefits based on the size of the IRA at $10 million is in the current bill and is a more practical solution to avoid billionaires skipping out on a huge tax bill. Adding the portion to limit the purchases to only public securities may not punish the rich from excesses as the policy makers intend and may end up actually hurting the little guy.

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