“People are upset.” Will Proposed IRA Tax Changes Targeting the Wealthy Hurt Smaller Nest Eggs?

Months after a story came out detailing the $5 billion that could come tax-free from Peter Thiel’s retirement account, new tax proposals aim to end the practice of very wealthy investors taking advantage of favorable tax laws on IRA accounts.

The changes offered by Congressional Democrats to the Ways and Means Committee would result in super-rich households having to drain some of their money and end their ability to switch to accounts with tax-exempt benefits.

The proposal would also block individual retirement accounts for certain types of investments usually reserved for more sophisticated investors, including interests in private companies or real estate transactions.

In order to retain the IRA’s tax benefits, anyone who already owns these types of investments must be given a two-year period to withdraw them from the account, the proposal says. As it stands, the proposal does not specify whether the rules restricting this type of investment only apply to people above a certain income threshold.

The provisions target financial big-timers who supposedly use retirement-related tax rules to unfairly drive away more and more wealth — but could they hit the little guy’s nest instead?

That’s what critics are saying when it comes to the rule changes about what type of investments are allowed within IRAs. Others who are behind the changes have their doubts. Now the question is how far the proposals will go.

“People want investment opportunities, and it’s unfortunate that this can deter people from investing in major US companies.


— Adam Bergman, Founder and CEO of IRA Financial Technologies

“People are angry. They play a game in a way, and after so many years, ‘No, no, we’re going to change the game on you,'” said Adam Bergman, founder and CEO of IRA Financial Technologies, a trust company that sells the kind of “self-directed” IRAs. which is suddenly in the spotlight with the proposals: “People want investment options, and it’s unfortunate that this can stop people from investing in big US companies.”

Bergman’s company serves more than 28,000 accounts with approximately $4 billion in assets under management. Those assets include pre-IPO stocks, real estate, cryptocurrency, precious metals and private placements. The average account balance is $125,000, he noted.

But Steven Rosenthal, senior fellow at the Tax Policy Center, says non-public investments don’t belong in retirement accounts. He says it’s a matter of fairness, tax compliance and investor protection when it comes to pension tax rules that have long favored wealthy households.

If Congress curtails this kind of investment in IRAs, “what bad things will happen? I don’t think bad things will happen. There will be portfolio shuffling,” Rosenthal said.

But will there be legislative changes? Rosenthal is not sure. “It’s a huge industry that the Ways and Means Committee takes on. We’ll see how successful they are. It’s a big hurdle.”

Leveling the playing field for low-income investors

“The intent of these provisions is to level the playing field for low- and moderate-income investors,” said a spokeswoman for the Ways and Means Committee, chaired by Rep. Richard Neal, a Democrat from Massachusetts. “The chairman wants as many Americans as possible to achieve long-term financial security. He and the policy makers are open to adjustments to make sure we get these proposals right.”

Here’s some context on the cleanup.

The typical way to grow wealth in a retirement account is exposure to the stock market and its arsenal of listed stocks, bonds, as well as the mutual funds and exchange-traded funds that come with it.

Thiel, co-founder of PayPal PYPL,
+1.06%,
reportedly turned a Roth IRA of about $2,000 into a $5 billion astronomical asset when he used the account to buy 1.7 million shares of the company three years before it went public, according to ProPublica. Because Roth IRAs are funded with after-tax dollars, distributions can go untaxed.

A spokesperson for Thiel did not return a request for comment.

Self-Directed IRA Accounts and Who Can Open Them

Thiel’s account shot like a bull’s eye as the stock appreciated. But experts note that Thiel achieved this feat on a technical level using a so-called “self-directed” IRA, an account capable of investing in a wide range of assets beyond what’s out there in the public markets.

And when people go beyond the public markets and invest in “unregistered securities”, the SEC says they can only do this if they are an “accredited investor.” An accredited investor is defined as someone with an earned income of at least $200,000, assets in excess of $1 million or a financial professional license in good standing, says the SEC.

The thinking is that those with the resources and investment experience are better equipped to handle investment crises in companies where there are no required SEC disclosures, the regulator said.

But investments aimed at experienced investors can give them access to opportunities that others miss. The Ways and Means Committee’s proposal said the bill “prohibits an IRA from holding securities if the security issuer requires the IRA owner to have a certain minimum level of assets or income, or have completed a minimum level of education or specific license or identification.”

The bill prohibits IRAs from “holding investments that are offered to accredited investors because those investments are securities not registered under federal securities laws.” said a summary.

‘Government should not choose and choose’

“These accounts belong to pension savers. They understand the investments they feel most comfortable with. We don’t believe government should pick and choose,” said Michael Hadley, a partner at Davis & Harman.

Hadley is a registered lobbyist on behalf of the Retirement Industry Trust Association, a trade association for the self-directed retirement plan industry. The group’s members have 3.8 million IRA accounts with $118 billion in assets, and just over 80% of assets are assets other than securities, mutual funds and cash equivalents, Hadley said.

The provision should be removed from the proposal entirely, along with a separate proposal that sets IRA interests in non-marketable investments at 10%, Hadley said.

“By cutting off this one source of capital, you don’t prevent the super-rich from accessing private placement. All you’re doing is preventing people who have the good resource or investment assets in an IRA from doing this,” he said.

People don’t necessarily have to be an accredited investor to participate in certain private deals, so the scope of the proposal could be further than it appears, Hadley said.

No one is trying to stop money from flowing into private investment, said Rosenthal, who doubts the proposed changes would stifle capital. Instead of a retirement account, he says, investors can buy a business through a brokerage account.

Rosenthal noted that he would give people more than two years to get targeted investments out of the IRAs if they’re already in one. “I have sympathy for someone who is trying to sell their assets,” he said.

One problem, Bergman said, is that investments in something like a private company may be illiquid and include lock-in periods that preclude sales before a certain date.

“Who wants a 3% stake in a private company? Not everyone,” he said.

Bergman recalled speaking to an account holder after news of the Ways and Means proposal got through. The person couldn’t figure out how to proceed with an impending investment. “It is already creating a capital bottleneck. Some people don’t know what to do,” he says.

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