Should You Invest in a Bitcoin IRA?

If you want to save for your retirement using bitcoin, you would need to use a self-directed individual retirement account (IRA). There's no IRS rule allowing cryptocurrencies in IRAs and most brokers and IRA providers do not allow cryptocurrencies in IRAs.

Self-directed IRAs may have additional fees that could make them more expensive compared to other traditional retirement plan options. But remember, cryptocurrencies can be extremely volatile, meaning they have the potential for big gains, but you can also face outsized losses. Putting your nest egg in an investment that can swing between those extremes, may not be a good idea.

What Is a Bitcoin IRA?

While you may see many references to bitcoin IRAs, there is no account specifically designed for cryptocurrencies. Nor does the IRS have specific rules permitting cryptocurrencies in IRAs.

Owning bitcoins in an IRA typically involves special planning because most IRA custodians only accept more mainstream assets such as stocks, bonds, mutual funds, REITS, money market funds, and certificates of deposits (CDs). This is where self-directed IRAs come into the picture.

Self-directed IRAs (SD-IRA) offering non-traditional investments have steadily increased in popularity in recent years. Self-directed IRAs have been used to invest in real estate, precious metals, notes, tax lien certificates, and private placements. More recently, self-directed IRAs have been used to hold cryptocurrencies. These self-directed IRAs allow you to buy and hold bitcoins or buy shares of dedicated funds that hold these assets.

Pros and Cons of Bitcoin Self-Directed IRAs

Not unlike any other investments, cryptocurrency self-directed IRAs have some advantages and disadvantages.

Benefits of Bitcoin Self-Directed IRA

• Exposure to bitcoin not available through other plans: Cryptocurrencies may not be available in retirement plans at work anytime soon. Retirement plan sponsors are liable for the type of investments they offer and cryptocurrencies are too volatile. While some government agencies around the world are preparing for these digital assets, they currently are not very well regulated.
  
  
• Tax advantage: The easiest way to own bitcoin and other virtual currencies is to hold them as regular taxable investments. As such, buying and selling decisions are subject to capital gains taxes. By focusing on some good old fashioned tax-diversification or "asset location," you can reduce the tax implications of buy and sell transactions. This is because self-directed IRAs give retirement savers the ability to invest in cryptocurrencies in a tax-deferred account. They do so by pairing self-directed IRAs with a cryptocurrency wallet that operates as a special account for virtual currencies. This can help reduce overall taxes. Choosing between a Roth and traditional IRA comes down to whether you prefer paying taxes now or later.
  
  
• Potential for big gains: While there is tremendous uncertainty about the long-term prospects of cryptos, bitcoin IRAs can provide significant upside potential. The possibility of large gains is what attracts many to place speculative investments in bitcoin and altcoins. The tax-free growth of earnings in a Roth IRA can be enticing for investors seeking to minimize taxes from those potential gains.

The Downside Risks of Bitcoin Self-Directed IRA

• Extreme volatility and potential for huge losses: Bitcoin and other digital cryptocurrencies are extremely volatile and are primarily viewed as a speculative investment. They differ from stocks in that they do not represent ownership in a corporation that has underlying valuation metrics such as price-to-earnings and price-to-book ratios. Cryptocurrencies do not generate earnings or dividends and are all based on prices which fluctuate significantly on a day-to-day basis. With so many cryptocurrency investments to choose from, it is impossible to predict which ones will be around for the long-term. Going forward, one way to reduce some of the risks would be to find a low-cost, exchange-traded fund that holds a basket of cryptocurrencies. 
  
  
• Additional fees: Self-directed IRAs can be more costly than IRAs offered through traditional brokerage firms. The additional custodial fees can be cost-prohibitive for smaller investors. If you are considering using a self-directed IRA custodian to hold virtual currency, be sure to do your homework on the overall costs associated with buying and selling cryptos.
  
  
• Fewer protections for investors and potential for fraud: Cryptocurrencies are a newer asset class and relatively less regulated compared to investment products. Custodians and providers offering self-directed cryptocurrency IRAs may have limited duties towards investors. Since the accounts are self-directed, the custodian will not vet the investments. Cryptocurrency investments are also susceptible to frauds and losses on account of hacks.
  

The Bottom Line

Many financial advisors suggest avoiding cryptocurrencies because of their volatile nature and lack of consistent performance as an investment over the long term. The fact that the cryptocurrency industry is still in its nascency and has few regulations, may also be something to keep in mind while evaluating a bitcoin IRA for retirement savings.

A diversified mix of asset classes such as stocks, bonds, and cash remains the most advisable core holdings of a retirement portfolio. There are other financial planning milestones that should be met prior to considering using a self-directed IRA to invest in bitcoin. For example, financial priorities include establishing an emergency fund, eliminating high-interest debt (i.e., credit cards, private student loans), and contributing enough to a retirement plan to capture an employer match.

Frequently Asked Questions (FAQs)