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You Can Buy Cryptocurrency With an IRA. But Should You?
You may have heard about people investing in Bitcoin and other digital currencies with their retirement account.
It sounds strange. But it is possible.
You can purchase cryptocurrency through a self-directed IRA, which is a tax-advantaged retirement account used to hold alternative investments, such as real estate, commodities, and yes, even cryptocurrency.
But why hold such a volatile asset like Bitcoin in a retirement account?
The short answer: Tax breaks.
Owning digital assets like crypto inside this type of IRA helps shield traders from paying taxes on investment transactions made within the account. If you sell an investment inside an IRA, you won’t owe taxes until you withdraw the money.
In contrast, transactions made on cryptocurrency exchanges or broker platforms like Robinhood are subject to short-term and long-term capital gains tax — whether you withdraw the money or not.
But self-directed IRAs aren’t right for the average investor — or even the average crypto investor.
Even if you believe in the long-term growth potential of Bitcoin or other virtual currencies, self-directed IRAs are complex and come with high fees.
Read on to learn how these accounts work to see if a self-directed IRA is right for you.
A self-directed IRA is a unique individual retirement account that lets you put your money in alternative assets.
Examples of alternative assets include:
Self-directed IRAs are intended for experienced investors. People use these accounts to chase higher returns and diversify their retirement funds outside of traditional assets.
Self-directed IRAs aren’t like any other retirement account you’ve heard about.
Unlike other retirement accounts, self-directed IRAs:
Here are some similarities between self-directed IRAs and other IRAs:
You’ll likely have a hard time opening a self-directed IRA.
Brokerage firms typically act as custodians for IRAs, but most big-name brokers like Vanguard and TD Ameritrade do not offer self-directed IRAs.
Instead, custodians of these accounts are often banks or trust companies that specialize in self-directed IRAs.
Examples of companies that offer custodians for self-directed IRAs include Millennium Trust Company, Pacific Premier Trust, Equity Trust, Madison Trust and IRA Financial.
To make things more complicated, you usually can’t buy non-traditional assets directly from a self-directed custodian. Instead, you must purchase them from another broker. Your IRA custodian only holds these assets after you’ve purchased them.
Each custodian determines which investments it will accept. Some custodians specialize in specific assets, like silver or Bitcoin, while others are more general.
To be clear: Some financial institutions — like Fidelity, Charles Schwab and Merrill Edge — claim to offer self-directed IRAs. In reality, these are self-managed IRAs that let you pick the traditional assets inside your account.
You can open many IRAs for free without paying account management or trading fees.
That’s not the case with self-directed IRAs.
From set-up fees to trading and account management fees, self-directed IRAs aren’t cheap to open or maintain.
On average, you can expect to pay between $250 and $395 to set up a new self-directed IRA, although costs vary from custodian to custodian.
Before you open one of these accounts, it’s essential to understand the costs and fees involved.
Many custodians charge a one-time establishment fee, a first-year annual fee, an annual renewal fee and quarterly custodian fees.
These costs can quickly add up, cutting into your IRA funds and earnings.
Tax breaks are a big reason investors choose self-directed IRAs.
When you set up one of these accounts, you can opt for a traditional or Roth version.
With a traditional IRA, you can usually take a tax deduction on any contributions you make to the account. Growth within the account is tax-deferred. When you withdraw money later, distributions are taxed as ordinary income.
With a Roth IRA, contributions don’t qualify for tax deductions. However, you get to enjoy tax-free withdrawals when you take money from your account down the road.
Here are other differences between a Roth and traditional IRA:
Self-directed IRAs typically aren’t set up to accommodate traditional assets like stocks and bonds. So you’ll need to maintain a separate IRA or 401(k) to carry out your more traditional retirement investing goals.
Because self-directed IRAs are so complex, you should find a financial advisor with experience managing investment deals for these types of accounts to help you with due diligence. Custodians aren’t allowed to provide financial advice.
A Bitcoin IRA is a marketing term coined by custodian companies to describe self-directed IRAs specifically structured to hold cryptocurrency investments. Bitcoin IRA is also the name of a company that specializes in these types of retirement accounts.
More online platforms are offering Bitcoin IRA services, including iTrustCapital, Coin IRA and BitIRA.
The company Bitcoin IRA said it’s processed more than $1.5 billion worth of transactions for more than 100,000 users since 2016, according to Bloomberg News.
These IRAs make it easier, and somewhat more secure, for small-time investors to create a self-directed IRA and add virtual currency to their retirement portfolio.
However, nearly all of these platforms still charge high fees like other self-directed custodians.
These specialized Bitcoin IRAs are complex. However, custodian companies like the ones mentioned above take care of most of the paperwork.
The most common way to get crypto investments into a self-directed IRA is through a process known as an IRA LLC with checkbook control.
After opening your account, a limited liability company is created, which the IRA owns. You can then pick your digital assets through the crypto exchange of your choice.
Here’s how it works.
Some IRA custodians have simplified the process for investors. For example, IRA Financial Group has integrated with Gemini, a leading cryptocurrency exchange. The new integration lets investors buy and sell digital currency in a self-directed IRA without the need of an LLC or third-party broker-firm.
Self-directed IRAs aren’t user-friendly. They’re complex, not widely available and expensive.
They simply don’t make sense for the average investor.
Here are three other reasons to think twice about using retirement savings to invest in cryptocurrency.
For the average person, the variety of investments in a regular IRA — like stocks, bonds, ETFs and mutual funds — offer great opportunities for diversification at a low cost.
Regular IRAs are quick and easy to set up. Custodians are plentiful and fees are minimal. Plus they enjoy the same tax perks as a self-directed IRA.
Unless you’re a savvy crypto investor who’s comfortable navigating complex tax rules, it’s best to do your crypto investing elsewhere.
Even if you’re comfortable with IRAs, using one to buy Bitcoin or other digital currencies may not be a great idea.
High fees could eat into your returns — especially if you plan on making a lot of transactions — and negate the tax savings you’re trying to achieve.
Given all those fees, your account would need to make significant gains to justify the investment. That makes buying a risky investment like cryptocurrency even riskier.
If you believe in the long-term growth potential of Bitcoin, you’re likely better off buying the digital currency directly from an exchange and holding it yourself long-term in a hardware or digital wallet.
Most experts recommend allocating no more than 10% of your entire investment portfolio to speculative assets like cryptocurrency.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.
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