A lot of people new to crypto are starting to ask if rolling their IRA into a Bitcoin IRA is an easier, safer way to invest. Of course, brokers like to advertise this, but buying crypto through an IRA involves more red tape and expenses than their ads reveal. Admittedly, the cryptocurrency space can be intimidating. However, investing in it through an IRA will not make understanding crypto any easier. In case you were thinking that using an IRA to invest in crypto would be an easy way to pick up some Bitcoin, let’s dispel that assumption right away.
There’s no such thing as a Bitcoin IRA
First of all, understand that a “Bitcoin IRA” doesn’t really exist. In order to hold Bitcoin in an IRA, you must enroll in a Self Directed IRA that handles Bitcoin. Self Directed IRAs are their own special creatures altogether and are normally sought after by those who are already investing. If you don’t really know what a Self Directed IRA is, check this quick overview Self Directed IRA – Is It For Me?
There are generally two types of Self Directed IRAs in which you can hold Bitcoin or cryptocurrencies:
- Custodial Self Directed IRA
- Self Directed IRA LLC
Custodial Self Directed IRA
In a custodial Self Directed IRA, your broker does not manage your investments for you. You are the one who has to direct the purchases and trades. So you need to study cryptocurrencies in the same way that you would study a company before deciding to purchase its stock. Simply put, if you’re not interested in the technology and use cases of crypto, invest in something you’re interested in instead. If you are interested but are new to cryptocurrency trading and investing, welcome to a crazy, fun and extremely risky space. Get ready to do some research. You can start with this overview, but at the end of the day, you’ve got to ask yourself a serious question: am I willing to risk my hard-earned retirement savings on a highly speculative investment?
An IRA does not free you from the responsibility of studying your investment.
After you set up your custodial Self Directed IRA and roll your funds into it, you tell your broker what coins you want to buy. Your broker takes your order and then executes it through a third party. So, you talk to your broker, and your broker talks to someone else who buys the crypto. This adds additional steps. As cryptocurrency prices change in seconds, it’s quite possible that a coin you want to buy changes in value before your order can be executed. This would make trading crypto through a custodial IRA extremely frustrating.
In addition, many Bitcoin IRA custodians hold both your digital wallet and your private keys. This means you don’t have direct control over them. You have to go through your custodian to access your funds. If you know anything about the history of Bitcoin, you will see the irony here. The very first sentence of Satoshi Nakamoto’s Bitcoin whitepaper from 2008 reads:
A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. – First sentence of Satoshi Nakamoto’s Bitcoin whitepaper
Custodial Self Directed IRAs aren’t cheap. Most charge a 15% brokerage fee on your assets in addition to other fees. Many Bitcoin brokers like to point out that crypto exchange fees of 1.5% to either cash in or cash out from fiat currency on exchanges would already take 3% of your cut, and they will absorb that for you. But we’re comparing 3% to 15%. On an IRA valued at $100,000, that’s a $12,000 difference.
Self Directed IRA LLC
Alternatively, you could open a Self Directed IRA LLC. In this case, you would set up the IRA with a custodian and step up an LLC. You direct your custodian to use your IRA to purchase the LLC. The IRA then holds the LLC, and the LLC holds the assets. Your IRA becomes the Sole Managing Member and you control the checkbook to the LLC’s business account. It’s from this account that you can purchase and trade cryptocurrencies within your IRA. This is why some call the Self Directed IRA LLC a Checkbook IRA.
A Self Directed IRA LLC allows you complete control over your investment choices and executions. You also hold your own wallet and secret keys. But…with more control also comes more responsibility. It would be wise to seek legal counsel for both setting up your LLC and making sure that your investments are done within the scope of the IRS Rules and Regs, or your IRA could be disqualified, your assets taxed and you could face additional penalties. The IRS is very touchy with retirement funds.
Brokers generally charge a flat fee and an annual yearly fee for a Self Directed IRA LLC. This can be a lot cheaper than a percentage of your assets over time if your crypto makes big gains. However, in addition to those fees, you’ll need to pay the annual fee to the Secretary of State where you incorporated your LLC, and the fees for legal counsel to make sure you are drawing within the lines. Account holders must provide an accurate annual valuation of their holdings. This could be especially tricky with crypto.
Why hold crypto in an IRA at all?
Taxes. Like a traditional IRA, you will not have to pay capital gains taxes on your assets. This allows your assets to grow more because there is more to grow. When you’re 59 1/2 years old, you can pull from your IRA and it will be taxed as income which is generally at a lower rate. You could also choose a Roth IRA in which case you would be taxed on your contributions now rather than later, and be able to pull your money out tax-free.
Who would benefit from a Bitcoin IRA?
Most people would not benefit from a Bitcoin IRA. It’s expensive and volatile.
But, savvy investors who already have enough assets in their IRAs to risk alternative investments, and who are interested in the crypto market, could save big on capital gains.
- Custodial Self Directed IRAs are expensive and would be better for long-term holders who believe the gains can outpace the fees than for traders who need complete control of their trades.
- Self Directed IRA LLCs are for people who already know what they’re doing and have the money to do it.
If you still want to roll your retirement savings into this, remember to diversify. Cryptocurrencies are extremely volatile. This IRA should only be a small part of your portfolio - the high-risk part. How much of your portfolio should be high risk? That depends on your age and risk tolerance. But in general, no more than 5% of your total liquid net worth should go into high-risk, speculative investments.
So, slow your roll, take your time and research. If you’re looking at this but haven’t played with crypto yet, buy a bit of coin with money you can afford to lose (seriously, it can go up and down by 50%+ in a day) and learn what it’s about first.
If you’re not interested in the technology, or you don’t understand it, why would you put your nest egg in it?
Retirement tip: Got a 401k? Make sure you understand your investment.
Photo by Andre Francois
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