December 10, 2021
According to a report in ProPublica last June, the co-founder of PayPal, Peter Theil, has a Roth IRA worth some $5 billion. No details were provided on how this personal information was obtained, which was surprising given that tax and financial information has privacy protections. Reportedly Theil funded his Roth IRA with PayPal shares worth $1,700, well within the contribution limits at the time. When PayPal was sold to eBay three years later, that investment ballooned in value to $28.5 million. Those funds were used, in turn, to invest in other rising companies, such as Facebook.
Even if the story is true, Mr. Theil did nothing illegal. Nevertheless, the story sparked outrage in Congress, and the Build Back Better Act includes some major changes for IRAs that seem responsive to that story.
The change that has received the most publicity is also the least consequential. Taxpayers who have aggregate vested accounts in defined contribution plans, including IRAs, 401(k)s, and 403(b)s, of $10 million or more would be prohibited from making a contribution to an IRA or a Roth IRA in years in which the taxpayer’s income exceeds $400,000 (for married filing jointly, $450,000). Rollovers, inherited IRAs, and transfers incident to divorce would not be considered contributions for this purpose. Note that the taxpayer would still be allowed to contribute to a 401(k) plan if available.
Changes to permitted IRA investments are much more important. Under current law, an IRA may not invest in a company in which the IRA owner has a 50% or greater ownership interest. This threshold would be lowered to 10%. The IRA also could not invest in securities available only to “qualified investors” who have a specified minimum income or assets—in other words, securities not available to the general public.
A new provision that seems spe- cifically to target Mr. Theil is an expansion of the required minimum distribution calculation for large IRAs and Roth IRAs. The general rule would be that half the account value in excess of $10 million would have to be distributed. A special rule would apply to Roth IRAs, for which 100% of the amounts greater than $20 million would have to be disgorged. The interaction of the two rules will be complicated. The 10% penalty for early withdrawals would not apply, but if the account owner is not yet 59 1⁄2 the income tax would apply to the distribution of earnings from a Roth IRA. Mr. Theil does not yet meet the age requirement.
Why it matters
Some may remember that one of the promises made by Bill Clinton when he campaigned for President was a 10% surtax on the incomes of millionaires. The tax was adopted after his election. Because the top tax rate was then 36%, the 10% surtax came to 3.6%, yielding a new top tax rate of 39.6%. We continue to have that tax bracket, the only bracket not expressed as a whole percentage. Interestingly, the definition of “millionaire” was brought down to those with an income of $250,000 or more.
The retirement plan changes con- templated by Congress have high thresholds today, accounts aggregating $10 million or more. The Joint Committee on Taxation scored the proposed changes to retirement plans as raising only some $4.3 billion over the ten-year budget window. Those high thresholds could be easily lowered should there be a need for more tax revenue in future years. According to the Investment Company Institute’s 2021 Fact Book, IRAs and defined contribution plans hold some $22 trillion in assets. That is serious money.