Crypto and Retirement Accounts: 401(k)s and IRAs

Crypto Retirement Plans Are Growing

As cryptocurrencies continue to grow into a pillar of the global economy, more and more traditionally-minded investors have begun exploring digital assets as part of their retirement plans. As a result, some service providers for the two primary types of retirement accounts in the U.S. – Individual Retirement Accounts (IRAs) and 401(k)s – are expanding their offerings to include crypto IRAs and crypto 401(k)s.

As of mid-2021, investors in the U.S. currently have $22.5 trillion USD tied up in IRAs and 401(k)s. They represent an enormous emerging market for both crypto-native service providers and forward-thinking legacy financial players alike. In a 2021 survey of over 500 financial advisors led by Financial Planning Association, 14% of respondents said they currently invest in or recommend cryptocurrencies for their clients – a marked increase from the 1% who responded affirmatively to this same question in 2019 and 2020.

Investing in Bitcoin 401(k) Accounts and Other Crypto 401(k) Plans

A 401(k) plan is a tax-advantaged retirement account that many employers offer to their employees. Employees can contribute to their 401(k) accounts through automatic payroll withholdings up to a pre-set annual limit, and employers typically match some or all of these contributions. Investment earnings made via a traditional 401(k) plan are not taxed until the employee withdraws that money upon retiring.

Most 401(k)s only allow employees to invest in mutual funds and exchange-traded funds (ETFs). However, if your employer offers a self-directed 401(k), you may be able to directly allocate your funds to alternative investment vehicles such as cryptocurrencies. 401(k) plans also generally have higher annual contribution limits than IRA accounts, which can be beneficial for investors who are trying to significantly increase their crypto exposure in a shorter amount of time.

Additionally, a number of FinTech startups have begun offering crypto-specific 401(k) plans to their institutional clients. In addition to its bitcoin payroll services, Bitwage launched the world’s first Bitcoin 401(k) offering in March 2021. ForUsAll, another 401(k) provider, announced that it would begin allowing clients’ employees to invest up to 5% of their 401(k) contributions in popular cryptocurrencies including bitcoin (BTC), ether (ETH), and litecoin (LTC). With $1.7 billion in retirement-plan assets, ForUsAll is only responsible for a sliver of the $22.5 trillion retirement account market. However, as mainstream interest in digital currencies continues to grow, many other 401(k) providers are now looking into crypto retirement plan offerings of their own.

Investing in Bitcoin IRA Plans and Other Crypto IRAs

An IRA account is a tax-advantaged account that allows investors to save for retirement with tax-free growth or on a tax-deferred basis. IRAs usually classify crypto as property, and income from buying or selling crypto via an IRA is usually treated as a capital gain — which, depending on the type of IRA, could be either tax-free or tax-deferred.

There are several different types of IRA accounts, and, as is the case with 401(k)s, the investment choices available in most IRAs are limited to fairly conservative financial products. As a result, when it comes to investing in crypto through an IRA, there are two main options to choose from:

Self-Directed IRAs (SDIRAs)

SDIRAs allow investors to invest in alternative asset classes that are typically excluded from conventional IRAs, such as real estate and precious metals. A growing number of SDIRA providers offer cryptocurrencies as one of their investment options. Examples of such SDIRA providers include Equity Trust, Alto IRA, and Directed IRA.

That being said, investing in crypto through an SDIRA takes some effort on the part of the investor. In order to hold assets in a crypto IRA, you must make the investments through a limited liability company (LLC) and place orders through a cryptocurrency exchange that is compatible with your crypto IRA provider. More specifically, one must:

1. Set up and fund an SDIRA with a service provider that lets you invest in crypto.

2. Form and register a limited liability company (LLC) that is 100% owned by the SDIRA and carries the same tax-advantaged status as the SDIRA.

3. Use the LLC to open a business checking account with the funds from your SDIRA, for the express purpose of investing in crypto and any other alternative assets allowed by your SDIRA provider.

4. Open an account on a cryptocurrency exchange using the name and tax number of your IRA LLC and begin trading. You may also be able to purchase and trade crypto via brokers or by investing in a private placement fund that holds crypto, depending on your SDIRA provider.

Crypto-Specific IRAs

In addition to SDIRAs, investors can choose from a growing list of IRA providers that are created specifically for investing in crypto. It’s important to note that when investing in crypto via an SDIRA, you retain control of the private keys to your digital assets, but most non-SDIRA crypto IRAs act as fund custodians with direct control over your crypto wallets. Their position as custodians also means these service providers can help you recover access to your crypto IRA account if you forget your password.

The investment process for this type of crypto IRA is similar to using an SDIRA, except you don’t need to set up an LLC to begin trading and investing in crypto. Instead, you can simply set up an IRA with a service provider, use your account details to create and fund an account on a participating crypto exchange, and begin trading immediately. A number of crypto-native startups such as BitcoinIRA and BitGo offer crypto IRAs, and several legacy retirement fund providers have also begun offering support for crypto investments. For instance, Directed Trust Company has a dozen different crypto IRA options, and Madison Trust Company, one of the world’s leading IRA providers, now offers a dedicated crypto IRA that lets users invest in BTC, bitcoin cash (BCH), ETH, LTC, and USDC.

Key Considerations When Selecting Crypto Retirement Plans

Investing in bitcoin and other cryptocurrencies for retirement can be a good diversifier and may enhance your investment returns. Conversely, it may also inject more risk into your retirement portfolio. Additionally, IRAs that allow you to invest in crypto may have high fees to cover the unique security and custody requirements and additional reporting duties required by the IRS for crypto investments. For instance, BitcoinIRA charges a $240 annual account fee and levies an average 1% and 5.5% fee each time users sell or buy crypto, respectively. On top of that, it can cost several thousand dollars just to set up and fund a SDIRA, and if you prematurely withdraw funds from a crypto retirement account, your earnings will likely be taxed at the standard capital gains rate. The sum of all these costs may effectively negate the tax advantages offered by IRA accounts, so it’s important to have a full understanding of what fees you can incur prior to setting up any retirement account.

Don’t Take Your Crypto Retirement Planning Lightly

Every crypto investor should carefully vet their potential investments and only use reputable exchanges and service providers that fully comply with local and federal regulations. This is especially true if you are investing for your retirement. For example, if you are interested in investing in crypto but aren’t sure that a bitcoin retirement account is the most fitting choice, you might consider buying BTC directly on a crypto exchange or other investment options.