In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses the Roth IRA, and the best way to amass tax-free retirement savings fast.

How to Boost your Self-Directed Roth IRA

Hey everyone, Adam Bergman here, tax attorney, founder of IRA Financial. On today’s episode, we’re going to be chatting about how you can boost and build up your Roth IRAs quick as possible. So, hope everyone is having a great day. It’s going to be a fun, fun podcast, so buckle up. Let’s get started.

So, 2023, what are the Roth IRA rules? Okay, so this podcast I’m going to start just breaking down what a Roth IRA is; the most common ways to fund IRAs, Roth IRAs, i. e. through contributions or rollovers, and then talk about some strategies to boost your Roth IRA.

So, number one, 2023, the Roth IRA contribution numbers have gone up from 2022. They are now $6,500 if you’re under 50 years old, or $7,500 if you’re over 50 years old. 2022, the numbers were $6,000 and $7,000 respectively. You can still make 2022 contributions up until April 15 for your Roth; so, you still have time to do it.

Generally, Roth IRAs also have income limitations. In 2022, if you made less than, if you’re married file jointly, and you made under $218,000, couldn’t do a Roth IRA now, excuse me, it was $214,000. In 2023, it’s $228,000, okay? And I’ll talk about the caveats. So, basically, in 2023, married file jointly, you make more than $228,000, you can’t have a Roth IRA, okay? If you’re single filer, the number is $153,000. If you’re married file separately, the number is $10,000.

But since 2010, there’s a workaround called the Backdoor Roth IRA. The way the Backdoor Roth IRA works is, irrespective of your income limitations, if you make $400 grand, $10 million, $100 million, you can still do a Roth IRA, even though I just told you you can’t. How does it work? Backdoor Roth IRA, you simply make an after-tax IRA contribution; you just convert it to Roth. Why can you do it now or not before? Well, prior to 2010, there were income limitations for Roth conversions because what a Backdoor Roth IRA is, you’re doing an after-tax IRA and then converting to Roth. But since it’s an after-tax contribution and not pretax, there shouldn’t be any tax on the conversion. Prior to 2010, if you had more than $100K of income, you cannot do a Roth conversion, but IRS, government loves conversions because people prematurely pay their tax, so they encourage conversions to help Treasury generate more tax revenue. So, that’s why I’m saying that no matter your income, you can do a Roth IRA, but your capped at $6,500, or $7,500 if you’re over 50. So, that’s the first way to fund a Roth: contributions.

Number two is through rollovers. What’s a rollover? It’s when you roll a Roth IRA from another IRA into a Self-Directed IRA Roth, or if you have a Roth 401(k), an employer plan, you leave your job, you’re over the age of 59 and a half, that triggers a triggering event, and then you move those funds tax-free from your former employer 401(k) or 457 or 403(b) into a Self-Directed Roth IRA. Now, if you have pretax IRA funds or pretax 401(k) funds, you can still roll them into a Roth IRA, but you have to convert them from pretax to Roth, which, unfortunately, is subject to an ordinary income tax rate based off the value of the cash being converted or the fair market value of the asset you convert. So, if it’s real estate, it’s not what you paid for it, it’s what it’s worth today, whether it’s higher or lower. And its ordinary income tax; there’s no penalty for doing a conversion; no withholding tax. But there is an ordinary income tax, not capital gains. So, that’s the second way you can fund and boost a Roth is through contribution.

And the third is through savvy investing, and this is where the interesting strategies come into play, where people can take a very small Roth IRA and then boost it into something pretty major, right? How do you do it? Well, the way most people do it is you buy underappreciated assets, whether it’s real estate, whether it’s small business stock, hedge fund/private equity interest and you hit some home runs, and by doing that in a Roth IRA, all those funds are able to grow tax free. So, talked about contributing money to a Roth; number two: rollovers, right? Those are the two ways you can fund a Roth IRA.

Why do you want to have a Roth IRA? Probably should’ve started with that. Sorry. Well, number one, it’s the tax-free growth, right? That’s the play. It’s the best legal tax shelter out there. Wrote a book on the Roth IRA called “In God We Trust and Roth We Prosper.” It’s true. So long as you’re over 59 and a half, the Roth’s been open at least five years. All your Roth IRA withdrawals/distributions are tax free. No capital gains tax, no ordinary income tax, nothing. Zip, zilch, nada, zero tax. So, that’s the play, right? It’s pretty simple. Even my nine year old son understands that you don’t want to pay tax if you don’t have to. Well, the Roth IRA, you don’t have to pay tax so long as the withdrawal, the distribution, is qualified; meaning you’re over the age of 59 and a half and, it’s not an or, and the Roth IRA has been open at least five years. So, now you understand the power of the Roth.

So, what’s the strategy? Well, you can call it whatever you want. I kind of call it the Peter Thiel strategy. PayPal is the perfect example of taking under $2,000; he actually used about $1,900 and invested it in a Roth IRA. Roth IRAs were created in 1997, so he did this in ’99, literally a couple of years after the Roth IRA was created, thanks to some really savvy advice by very smart gentleman who worked in the self-directed retirement space. He met Peter Thiel in San Francisco and said, hey, there’s this thing called a Roth IRA you may want to look at using to invest in these startups. Now, Peter Thiel is super smart guy; he went to Stanford Law. He was in private equity venture capital. Very, very smart guy. And he took under $2,000 in a Roth IRA and turned it into approximately $28.5 million tax-free by investing that $1,800-$1,900, actually, it’s about $1,700 buying shares at 0.0001 cent, which was what every co-founder paid for their shares. He was just smart enough to do in a Roth and you may be saying, well, how’s that possible? It has to be a prohibited transaction. Adam, you spend so much time talking about prohibited transactions, disqualified people, how the heck was he able to turn $1,700 into 28 and a half million bucks in a couple of years? Well, the answer is let’s do the analysis. How about that?

So, under Internal Revenue Code Section 4975, and this is important because it goes to the whole strategy of hitting home runs in a Roth. Number one, he was a young, young gentleman. Number two, he saw the upside of PayPal, right? He had Elon Musk, there’s other super smart co-founders. They were going to set up this digital platform for moving money around the world, and it was going to transform global finance. So, they were super excited, super amount of upside. Now, the downside was minimal, right? It was only $2,000, right? He put in $1,700. If the company goes belly up, big deal, he loses $1,700. So, he had a very good risk versus reward proposition there. Very, very low risk, very, very, very, very high reward in his estimation.

So, how do you analyze if something is prohibited? Well, there’s three things you cannot do with an IRA: life insurance, collectibles is two, we’re not dealing with that here. Third, under Internal Revenue Code section 4975, you’re essentially, in sum, not allowed to do anything with your IRA that directly or indirectly personally benefits disqualified person, okay, and what’s the disqualified person? Disqualified person is the IRA owner, any of his or her lineal descendants or any entities, PayPal is an entity, 50% or more control of such persons. Well, he is only going to buy 1.7 million shares. He owned a very, very small percentage of PayPal, very, very, very clearly under 50%. He was also paying fair market value because the par value, the 0.0001 cent he paid per share is what every co-founder paid. So, the IRS wasn’t able to attack the transaction on the prohibited transaction rules because it was less than 50%. They weren’t able to attack it on valuation because he paid the same amount as everyone else. And thirdly, it’s hard to argue that $1,700 is going to make it or break it for PayPal, right? There’s situations where, let’s say, he invested $100K or $400K in a start-up; even if he owned 7% or 3% or 8%, the IRS could argue that money was significant and he didn’t do the investment to personally benefit his IRA, but he did it to help himself personally, right? Let’s say he was working there, he was an executive. That $400K was needed to kind of operate and get the business off the ground. In the case at hand with Thiel and PayPal, under 50%, a very minimal amount of money, plus the $2K and he paid fair market value, the same as everything, so, as everyone else, at that time.

So, if you take those three categories, you can then apply it to your potential situation. Whether it’s a friend’s business, whether it’s a venture capital fund, whether it’s even a business you’re involved in, under 50%, you pay the same amount as every other person at the time of the IRA invests, and you can show there’s no personal benefit directly or indirectly, and clearly the less amount of money you put in, it’s going to be hard to argue from the IRS perspective that that’s going to move the needle. So, he then took that 28 and a half million bucks and, actually where he made the most money wasn’t PayPal, is he was one of the first investors into Facebook and he took $500K in a Roth IRA and he turned that into $870 million, right? He’s literally one of the first investors; he met Zuckerberg, and he invested $500K in a Roth and that became $870 million. So, I’m not saying that’s possible. That’s why I call it the Thiel strategy.

It’s kind of really the Super Bowl, say, the World Series, the Academy Awards, whatever you want to call, that’s the highest level, Nobel Peace Prize, the highest level you’re ever going to reach in a Roth IRA. And that’s just not going to happen for pretty much any of us. But, if you take the strategy of saying, hey, I’m going to buy distressed assets or assets that has high, high, high reward versus risk profile, so if it’s a very low reward investment, then yeah, you could still do it in a Roth, but it’s going to be hard to really boost the value. But, if you have founder stock, whether you have startup shares, undervalued real estate, access to a really good investment fund, hedge fund, venture capital fund, private equity fund with lots of upside, great track record, then doing the Roth could make a lot of sense, especially if you’re young and you’re patient, right? The patience is super important because to really benefit from the full, full grasp, full, full circle of potential benefit of the Roth and really close that circle is you got to wait till 59 and a half and the Roth’s been open five years. So, if you take premature distributions, you’re going to essentially eliminate a lot of the built-in inherent value because you’re not going to get the full tax-free growth in the account.

So yeah, you got to be a good investor, helps to start young and you got to get lucky, clearly. Like, Peter Thiel is smart, but he also got lucky, right? Facebook could have been a dud, PayPal could have been a dud, but they turned out to be monster companies and that’s why it’s like the gold standard. But I’ve seen over the years, I’ve seen clients go from the hundreds to the tens of millions and I’ve seen the reverse, right? I’ve seen hundreds of thousands to zero. So, if you’re doing risky investments in a Roth, obviously you love the huge upside, and if you’re going to do the huge upside, why not do it in a tax-sheltered account? Makes sense, right? Again, my nine year old kid could figure that out. But, the risk is on a high-risk investment is you can lose your money.

Now some people would say, well, you shouldn’t do high risk investments in a Roth, just hit singles and doubles and just kind of build that up over the next 10, 20, 40 years and you’re going to have a huge, huge Roth IRA tax-free. Fair, right? The problem with doing risky investments in a Roth is you don’t get a deduction to a loss, it just depletes the Roth. So, some people say, well, you should do those risky investments, maybe personal funds, get the loss deduction. I don’t know. I take the position honestly and I’ve done it for myself, for me, not paying tax outweighs any deductions. And obviously when you do an investment, you’re confident, right? You’re positive. It’s hard to go through an investment, say I’m going to lose my shirt. It’s like going to, being a major league baseball player and going to take an at-bat and say, yeah, I’m going to definitely strike out or at a foul line at a basketball game, saying I’m definitely missing both foul shots or kicker saying I’m definitely going wide left here. No. You go into an investment thinking you’re going to do it. Now you want to be reasonable and you want to be, I guess, somewhat objective in its potential risk versus reward. But to say well I’m doing this because I’m going to lose money, get a deduction; I’d rather go in saying, hey, I’m going to hopefully do well and I’d rather shelter any gains from tax. To me that’s more valuable than getting a deduction for a loss. But that’s me. That’s up to you.

So, how do you take advantage of the Thiel strategy? Well, Thiel didn’t need a lot of money, right? He did it with less than $2K. Nowadays, it’s hard to do that, right? So, $6,500, $7,500, which is the max for a Roth; not always going to work out, right? Sometimes you’re going to need more money. So second way, fund it through a contribution; rollover is number two. Let’s say you don’t have any Roth money, right? You just got pretax money. The only other way to fund it is through a conversion. Conversions are subject to tax. The advantage of potentially doing a conversion in ’23 is that if you’re converting stocks or cryptos or real estate, it may be down in value, which allows you to pay tax at a depressed value. And then thirdly, whether you want to hit singles and doubles or do very high, risky, high reward investments, obviously you’re the investor; you hopefully know what you’re doing and believe what you’re doing. It’s a Self-Directed Roth account. We don’t give investment advice. It’s up to you. But if you do hit home runs, then so long as you’re patient, you wait till you’re 59 and a half, the Roth’s been open at least five years, it’s all tax free, and to me, that’s the ultimate tax shelter. That’s why I wrote a book on the Roth. That’s why I have all my retirement funds in Roth. And that’s why as a tax lawyer, someone with a Masters in taxation, it’s why I jumped into the self-directed industry 13 years ago. I was a practicing tax law for nine years. This is one industry that I was like, oh yeah, it makes sense. It’s just like, holy cow, this whole damn system is rigged in our favor. Like, they’re literally giving us a chance to never pay tax again. Let me help people do this. And not only do you have to, not only you get the tax-free potential, but you can actually invest in almost anything you want; not just stocks or bonds and boring stuff, but you can do cool stuff like startups or private equity, venture capital, cryptos, hard money loans, real estate, commercial, residential, foreign, domestic. There’s so much you can do. It’s so much fun. But, yeah, obviously it’s the downside of not getting lucky on your investment and your Roth dropping in value. But the Thiel is the ultimate upside where you hit home runs, not just home runs, but like super duper grand slams, Bo Jackson-type home runs, out of the ballpark and it’s all tax free.

So, that’s how you boost your Roth IRA. Either you start with contributions, you hopefully add to it through rollovers or conversions, and then thirdly, you become a very super slick, successful, lucky investor. And you take what you have and you boost it up through smart investing, and ultimately you stay patient, wait till you’re 59 and a half, the Roth’s been open five years. It’s all tax free. That’s the name of the game, right? Doing what you can, using the tax code to your advantage and sheltering income tax, that’s what makes a smart investor. And Peter Thiel, whatever you want to think of him, his political affiliation, it’s a little out there. I don’t care about that. From an investment standpoint, I think he’s brilliant, and putting politics aside, he set forth a path that if we emulate, we potentially may not be able to hit Facebook/Palantir/PayPal-type growth investments, but whether it’s a neighborhood restaurant or your friend’s chatGPT, new startup or AI or crypto, whatever it is, you could potentially take thousands and turn it into millions. It’s possible. It’s not guaranteed, but it’s possible, and if it’s possible, why not do it in a Roth IRA?

So, hope you guys enjoyed today’s podcast. If you’re watching on YouTube, thank you very much. Don’t forget to subscribe, leave a comment. I promise I’ll do my best to get back to you and respond ASAP. Otherwise, really appreciate you guys listening and watching. A lot of fun. It’s a weekly podcast as you guys know, it drops every Wednesday and check it out again next week. Other than that, have a great, great, great day, great rest of your week. Cheers. Take care.