Cryptocurrency IRA: An Overview
There is no specific Individual Retirement Account (IRA) recognized by the Internal Revenue Service (IRS) designed for cryptocurrencies. Thus, when you hear about a "cryptocurrency IRA" or "Bitcoin IRA," it is an IRA that includes digital currencies within its portfolio of holdings.
Since 2014, the IRS has taxed cryptocurrencies as property, meaning they are taxed in the same fashion as stocks, bonds, or other investment types. Like the other investments, they cannot be placed into an IRA by the account holder. This means that if you want to put crypto in your IRA, you must enlist the help of a custodian.
The issue you'll run into is that finding a custodian that accepts crypto in an IRA can be challenging. Fortunately, self-directed IRAs (SDIRAs) more frequently allow for alternative assets like cryptocurrencies.
Custodians and other companies designed to help investors include cryptocurrency in their IRAs have become increasingly popular. Some examples are BitIRA, Equity Trust, and Bitcoin IRA, one of the early leaders in the field.
- A cryptocurrency IRA is an IRA with cryptocurrencies in its portfolio.
- To the IRS, cryptocurrencies are considered and taxed as property.
- A few advantages of cryptocurrencies are that they diversity portfolios, are expected to grow in popularity and availability, and may benefit investors with favorable tax treatment.
- A few disadvantages include hefty fees, extreme volatility, and significant risk.
The Advantages of Cryptocurrency IRAs
You may find that including cryptocurrency holdings can add diversification to retirement portfolios. This may help to protect those retirement accounts in the event of a major market downturn or other tumultuous activity in the future.
Perhaps more than diversification, investors inclined to add crypto holdings to their IRAs likely believe that cryptocurrencies will continue to grow in popularity and accessibility into the future. With their long-term outlook, IRAs are an excellent vehicle for investments with significant potential over decades.
Growth potential is accompanied by a significant risk of losses, but some investors feel that the possibility of growth outweighs the risks.
If you're determined to invest in cryptocurrency, avoiding hefty capital gains taxes may be possible by including digital currencies in retirement accounts using a tax strategy. For example, placing cryptocurrency in a Roth IRA lets you realize any capital gains without being taxed since you already paid taxes on the funds in the account.
If you place your crypto in a regular IRA, you pay income taxes when you withdraw from it. This could give you a tax advantage if your income—and possibly your tax bracket—is reduced after you begin taking withdrawals from your IRA.
Taxes for trading within your regular IRA are the same as trading stocks in one—you don't pay taxes on profitable trades, only when you make a withdrawal. Trading crypto from a Roth IRA would receive the same tax treatment as holding it in one.
The Disadvantages of Cryptocurrency IRAs
For many, extreme volatility makes crypto a tough sell as a retirement investment. For example, the leading cryptocurrency, Bitcoin, routinely experiences significant price fluctuations; since 2009, it has gone from virtually no value to $69,000, then back down to hover around $20,000. This makes it unsuitable for someone approaching retirement who needs stable and liquid assets; however, it might make sense for someone who has decades before they retire.
Volatility brings the risk of loss in the form of large swings in value. For example, if you purchased a cryptocurrency for $1,000, its price could fall more than 75% over a few months and never recover. In this case, you'd lose $750—larger investments would amplify the losses.
Many cryptocurrencies are not backed by businesses or assets, so they may lose the interest of the public and investors after you purchase them. Most are only supported by the belief that they are worth something—if that belief ever waivers on a large scale, cryptocurrencies could collapse and take billions of dollars with them.
Account and Trading Fees
Another key disadvantage of including crypto in an IRA is the fees. Crypto trading through an IRA differs from regular stock trading or trading at cryptocurrency exchanges, which are not custodians.
Because broker fiduciary duties do not bind firms offering self-directed IRA services, it is your responsibility to assess the risks associated with crypto markets and take measures to mitigate them.
Fees for crypto trading take on various forms during the investment process. Fees range from initial setup fees, to custody and trading fees, to annual maintenance fees. For example, setting up a $50,000 self-directed IRA account for trading can cost several thousand dollars in charges during an initial setup depending on the provider. There are also recurring custody and maintenance fees charged by providers of these services.
Finally, each cryptocurrency trade incurs fees from the service provider’s trading partner and custodian. A typical provider may charge 3.5% per transaction per purchase and 1% or a flat fee for each sale.
Cryptocurrency has unique requirements, such as security or custody, which tend to bump fees up for services offered through IRA accounts. IRA custodians working with cryptocurrency must also be prepared to take on additional reporting duties with the IRS—this could translate into even more fees for cryptocurrency IRA investors.
When looking for a custodian to execute your crypto wishes, you'll find plenty of scams or fraudulent companies offering services. The U.S. Commodities Futures Commission (CFTC) and Securities and Exchange Commission have issued alerts about fraudulent cryptocurrency IRAs. The CFTC issued a warning about false crypto IRA companies that claim the IRS approves them.
If you're in the market for a crypto IRA, it's best to speak with a certified financial advisor familiar with cryptocurrency to ensure your money is being put to its best use.
Can I Buy Crypto in a Self-Directed Roth IRA?
While you're not allowed to purchase cryptocurrency and place it in a Roth IRA, you can use a custodial service provider to use funds from your IRA to place crypto in your retirement account.
Can You Put Cryptocurrency in a Roth IRA?
You can use IRA custodians to place cryptocurrency in your IRA, but you're not allowed to put them there yourself under IRS rules.
Can I Use My IRA to Buy Cryptocurrency?
Yes. Again, cryptocurrencies must be bought by a custodian to be placed in your IRA.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.