I recently saw a post on Instagram shared by a personal finance coach berating anyone not taking advantage of a Roth 401(k). He used Mitt Romney’s $102 million individual retirement account (IRA) as the basis for the statement. Unfortunately, he was misinformed.
That’s not a Roth 401(k)
First, Mitt Romney has an IRA, not a 401(k), estimated between $20 million and $102 million. Further, his account is not a Roth IRA. He will have to pay income tax when he begins contributions at age 70. Mr. Romney had a simplified employer pension (SEP) IRA at the company he founded, Bain Capital.
At the time, he was maximizing his deposits into the account at $30,000 annually. In 2019, you can contribute $56,000 or 25 percent of your compensation in a SEP-IRA, plus an additional $6,000 if over 50 years old. He then used the funds in that account to make investments through the private equity company, netting him substantial returns as the founder.
Was it the best move?
Not only is this not typical, but it also may not have been the smartest move. Had Mr. Romney invested with non-IRA funds, he would pay taxes at the capital gains rate, which is about half of the income tax rate. The 2019 tax bracket for income at $510,300 or higher is 37 percent. Given the required minimum distribution (RMD), Mitt is looking at getting taxed on over $2,000,000 each year on this one account. He would end up paying at least $740,000 in taxes on the $2 million distribution. If he has multiple IRAs, which is very likely, then he will need to calculate the RMD for each then withdraw the funds from one or more of the IRA accounts.
Capital Gains vs. Income Tax
If he had taken the capital gains route, he’d pay a 20 percent tax rate, saving him $340,000 for this SEP-IRA. The capital gains rate is generally 15 percent or lower. However, I expect his income to exceed the highest tax bracket so the capital gains rate is higher. He also won’t be able to offset his gains with losses because the maximum loss for the year is $3,000, which barely puts a dent in what he would owe. Keep in mind, this still doesn’t take into account state taxes.
What if he had a Roth IRA?
But what if he managed all of that wealth within a Roth IRA? He couldn’t have. Roth IRAs weren’t available until 1998. Reports say that Mr. Romney maxed out his contributions at $30,000 per year. The maximum SEP-IRA contribution was $30,000 back in 1997, with it reducing in 1998 to $24,000.
Additionally, the tax brackets were higher then; if he kept his investments for less than a year, he’d pay a tax rate of 39.6 percent upfront. However, he’d have 20 years of compound interest to recover his losses. If he paid the capital gains rate after holding the investment for longer than a year, his tax rate would be between 20 and 28 percent. The rate changed mid-year in 1997, so it would depend on when he bought and sold.
This scenario provides a prime example of a convoluted situation that is not probable in this day and age for the average person. Mitt Romney had a recipe for financial success that most of us won’t understand. However, he will surely make up for it in taxes.