Members of Congress frequently claim they want to make it easier for working people to scrape together enough savings to have some financial security in retirement. But lawmakers’ preferred method to (ostensibly) achieve this goal is through tax breaks that have allowed the tech mogul Peter Thiel to avoid taxes on $5 billion. This is just one of the eye-popping revelations in the latest expose from ProPublica.

According to ProPublica, Thiel, who made some of his billions as the co-founder of PayPal, in the late 1990s exploited loose tax rules to funnel devalued corporate stock into a Roth IRA. The Roth IRA is now worth $5 billion, and Thiel will never pay taxes on any of it.

When Congress decides to provide a subsidy through the tax code to encourage retirement savings, no lawmaker ever claims that their goal is to help the extraordinarily wealthy accumulate even more wealth tax-free. But that is exactly what happens.

How Individual Retirement Accounts (Are Supposed to) Work

Congress created Individual Retirement Accounts (IRAs) for people who did not have access to an employer-sponsored retirement savings vehicle like a defined benefits plan (an old-school pension) or a defined contributions plan (such as a 401k). Lawmakers eventually expanded eligibility, although the tax benefits vary depending on a person’s situation.

For example, a person who does not have an employer-provided retirement savings plan and who does not have a spouse with an employer-provided savings plan can generally make tax-deductible contributions to a traditional IRA and not pay taxes on the income generated by the assets in the IRA until retirement. Those with an employer-provided retirement plan may be able to make tax-deductible contributions, depending on their income. But even those who cannot make tax-deductible contributions can contribute after-tax dollars and defer tax on the income generated until retirement.

The tax savings compound over the years, meaning the nest egg is allowed to grow much more rapidly than would be the case if the income generated by the assets in the IRA was taxed each year.

A Roth IRA is another type of IRA that accomplishes a similar goal through a slightly different route. The contributions to a Roth IRA are not tax-deductible but the income received in retirement from the account is tax-free.

These breaks are subsidies provided through the tax code to encourage retirement savings, so there are rules that are supposed to ensure that this subsidy goes to people who need it. For example, in 2021, individuals cannot contribute more than $6,000 annually to a traditional IRA or Roth IRA. (Individuals aged 50 or older can make an additional “catch-up” contribution of $1,000 annually.)

So, how in the world does someone like Peter Thiel end up with a Roth IRA worth $5 billion? Through various schemes that ordinary people will never, ever, have access to.

How Are Some IRAs Worth Millions or Billions of Dollars?

The phenomenon of oversized IRAs is not new. During the 2012 presidential campaign, the public learned that candidate Mitt Romney had an IRA worth as much as $101 million. In 2014, the Government Accountability Office (GAO) issued a report exploring how often this happens and why.

Saving money is easy for the well-off but difficult for many other people. GAO found that of the 146 million people eligible to contribute to an IRA in 2010, only 8 percent did so. And of that 8 percent, only around 1 percent managed to somehow accumulate more than $1 million in their IRA. This group nonetheless accounted for 22 percent of assets in IRAs, which strongly suggests that IRA benefits are skewed to those who do not need much help saving for retirement. The GAO also found that some people managed to accumulate more than $5 million, $10 million and even $25 million in their IRAs.

How did they do it? By talking with people in the financial industry and reviewing the data, GAO came up with a few explanations, all of which point to schemes that are not available to normal people.

For example, founders of a startup company will sometimes pay themselves and some key employees with non-publicly traded stock that they claim is worth almost nothing at the time. Companies are exempt from registering with the SEC if they sell securities only to accredited investors or other sophisticated investors. Even within this small group of people, only a few benefit from this technique. Very few people are founding companies that could become profit-generating behemoths or are the key employees when these companies are getting off the ground.

It is true that many startups fail, so it is not obvious initially whether the shares will be worth anything in the future. By claiming that the shares are worth very little, this small group of insiders can place them in their IRAs without overtly exceeding the contribution limits. But when the companies become enormously successful, the stock value soars and the IRAs suddenly contain assets that are worth millions of dollars.

Private equity fund managers and hedge fund managers often do something similar, placing profit interests in an IRA, initially claiming that these interests are worth very little because no money is being invested. Instead, managers agree to provide their work.

Part of the problem is the laws themselves, meaning Congress failed to draft legislation that targets tax savings for retirement toward those who need them. Another part of the problem could be that wealthy taxpayers are breaking the law, but the IRS has trouble enforcing it.

Some people in the financial industry that the GAO investors spoke with said that hugely oversized IRAs are likely an indication that taxpayers severely undervalued the assets they placed in IRAs. After all, do the founders of enormously profitable companies truly not know that they are worth anything initially?

There are several reasons why the IRS has difficulty preventing this. One is that Congress has not appropriated the resources to investigate every suspicious IRA, a problem that hopefully would be addressed to some extent by the Biden administration’s proposal to increase IRS funding and improve enforcement.

Other reasons have to do with the technical rules around how tax laws are enforced. For example, the statute of limitations for tax laws is generally three years. Founders and employees of companies and private equity funds that do not see profits until four or five years after their founding will, therefore, pay no consequences for undervaluing the assets they place in IRAs.

Congress could fundamentally rethink retirement policy in the United States to target help to those who need it, which the current system fails to do. Even if lawmakers are in no mood for a fundamental overhaul of the system, they could make improvements that would prevent the abuses revealed by the ProPublica expose.

For example, the Obama administration proposed to limit assets that accumulate in tax-favored retirement vehicles (like IRAs and 401ks) so that they would not produce an income stream during retirement of more than around $200,000. This seems like a perfectly reasonable limit on these types of tax breaks. (See page 166 of this explanation of the revenue proposals in President Obama’s last budget plan.)

Until Congress acts, we can expect the wealthiest will continue to hijack tax breaks that are supposed to help ordinary people save for retirement.

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