Does cryptocurrency belong in your retirement account?
A recent issue of the Slott Report, published by retirement advisers Ed Slott & Co. (irahelp.com), covered some of the pros and cons of investing in cryptocurrencies in a retirement account.
There is no rule against investing in cryptocurrency in your IRA, whether it’s bitcoin or some other variety. However, you should be aware of some potential disadvantages. If crypto is held in a traditional IRA or 401(k), any withdrawals will be fully taxable. If you hold crypto investments in a taxable account, the investment can potentially be eligible for long-term treatment, which could result in lower taxes. So, if you do decide to invest in crypto in your retirement account, a Roth account would have tax advantages.
You cannot add a crypto investment to your IRA. You must contribute cash and then buy the crypto investment within the IRA. If you establish a self-directed IRA to buy crypto, be aware that the fees can be higher than if you use a traditional IRA that is not self-directed.
Also be aware that custodial issues exist with crypto investments that do not exist with other IRA investments. For example, when you invest in crypto, whether it is in a retirement or other account, the investment exists as lines of computer code in a digital “wallet.” The Department of Labor (DOL) warns that simply losing or forgetting a password can result in the loss of the asset value forever. In addition, crypto investments are vulnerable to computer hacks and thefts that are specific to crypto investments.
When you invest in crypto in retirement accounts, the annual fair market value must be reported to the IRS. There are no exceptions. According to the DOL, there are fundamental disagreements about how the crypto market is valued. So you should determine from the financial institution offering the crypto investment whether there are any issues raised by the IRS as to the value of the crypto you are purchasing.
Some financial institutions (Fidelity is one example) have indicated they will accept crypto investments in 401(k)s for which they act as custodians. However, the employer associated with the 401(k) would have to approve the specific crypto investment. The DOL has warned employers against adding crypto to the 401(k)s they establish.
The DOL has issued Compliance Assistance Release No. 2022-01, which states: “Crypto or cryptocurrencies are very different from typical retirement plan investments, and it can be extraordinarily difficult, even for expert investors, to evaluate these assets and separate the facts from the hype.”
Ed Slott & Co. offered an action plan for his advisers to their client as follows:
Know the basics of how crypto works. (My recommendation would be to read “The Truth About Crypto,” written by Ric Edelman, published by Simon and Schuster.)
Understand that IRAs are different. The tax consequences are different in a traditional IRA than they are in a taxable account.
Roth IRAs provide the potential for tax-free gains.
Learn how to acquire crypto in an IRA. You must have a reliable IRA custodian to hold your crypto investment. (These issues are covered in Edelman’s book.)
Understand the issues associated with maintaining crypto in your retirement account. This includes fees, custodial issues and the rapidly changing rules and regulations.
Don’t disregard risk. There is no longterm historical track record for crypto, in comparison to traditional retirement account investments. Although crypto investments add diversification to your portfolio, proceed with caution. You don’t want to jeopardize your portfolio with too high a crypto investment. (Edelman recommends not more than 1% of your portfolio, acquired using dollar-cost-averaging).
Bottom line: As the recent volatile market shows, short-term results for crypto as well as other investments don’t guarantee continuous market gains. A diversified portfolio is necessary, and yearly balancing is very important. For retirees, it is important to have a realistic portion of your investments in safe, conservative investments in order to weather volatile markets.