Cryptocurrencies have been falling for the past couple of weeks but I am still bullish on long term cryptocurrency ira investing.
Saving for retirement is a major financial goal. The vehicle that the majority of (US) investors use is the Individual Retirement Account (“IRA”). IRAs provide a host of tax benefits. Most investors use them to invest in ‘traditional’ investments such as stocks, bonds, and mutual/index funds.
But in recent years, self-directed IRAs have become more popular. According to global consulting firm McKinsey:
“Global alternative investments across retail and institutional segments doubled in AUM between 2005 and 2011, to $6.5 trillion”.
This is because self-directed IRAs allow you to invest in a far greater range of investments than what you would get in a traditional IRA.
As the name implies, it is simply an IRA where the owner of the account handles all investment decisions made through said account. This freedom allows the account owner, you, to invest in alternative investments such as real estate, precious metals, collectibles, and yes, even cryptocurrencies.
You have plenty of options when choosing a self-directed IRA custodian. However, it would also depend on which alternative asset class you wish to invest in. Once you’ve selected a reputable and relevant custodian, you can then fund your self-directed IRA as per the standard IRA rules (up to $5,500 per year if you’re under 50 and $6,500 per year if you’re over 50). You can also choose to roll over funds from other retirement plans, such as your regular IRAs or 401(k) into your self-directed IRA.
The withdrawal age for a self-directed IRA remains at 59.5, with a 10% early withdrawal penalty. Like the standard IRA, self-directed IRAs can also be traditional (tax deductible in contribution year, taxable upon withdrawal) and Roth self-directed IRAs (taxed on contribution, tax-free on withdrawal).
When deciding between the two you should consider your current and expected income levels, as well as years to retirement. A rule of thumb is that if you are closer to retirement age and with a high income tax bracket, the traditional IRA is a better choice, and vice versa. Here’s a handy comparison table.
A cryptocurrency IRA is a self-directed IRA that is being used to invest in cryptocurrencies. Some people refer to them by the type of cryptocurrency that the IRA holds e.g. Bitcoin IRAs or Ethereum IRAs. For all intents and purposes, they are exactly the same thing.
Before 2014, the IRS’ stance on cryptocurrency holdings and taxations was still unclear. Fortunately in 2014 they issued a notice stating that virtual currency is to be treated as property for federal tax purposes. This clarified things and opened up the way for cryptocurrency IRAs.
But just because you can use your IRA to invest in cryptocurrencies, should you? Let’s consider the main pros and cons.
Portfolio Diversification Away From Fiat Currencies – Most of the currencies in the world used to be backed by gold. Not anymore. Central banks continuously print more money to accommodate their monetary policies, and intelligent investors are rightfully wary. Unlike fiat currencies, each specific cryptocurrency is only in limited supply. For instance, Bitcoin has a hard limit of 21 million coins (of which less than 16.5 million have been mined so far).
Explosive Growth Potential – This one seems obvious. To say that Bitcoin has exploded in value would be an understatement. As of Dec 2017, it is trading at about $15,000, an appreciation of more than 15 times since the beginning of the year! Another cryptocurrency, Ethereum has also seen a price increase of more than 50 times. Putting a small percentage of your retirement portfolio into cryptocurrencies could result in outsized gains. There are no guarantees, but this is a risk that many consider well worth taking.
Long Time Horizon – There is little doubt that cryptocurrencies are here to stay. But the question is, which ones? There are currently over 1,300 cryptocurrencies in existence. Over the long term, it is hard to guess which ones will become the ‘staples’. Bitcoin may have started it all, but it might not be the one that survives. This long term horizon is particularly an issue since we are talking about using a self-directed IRA, in which you cannot make withdrawals without penalty until age 59.5. The farther away you are from retirement age, the higher the risk.
High Volatility – Cryptocurrencies are extremely volatile. This is due to their limited supply coupled with the fact with that their total value remains relatively small still (a $416 billion total market cap, which is less than Apple). However you will be somewhat protected against this volatility if you are investing in them via an IRA due to withdrawal rules. Even so it can be nerve wracking to watch the value of your investments move so much. If you are not emotionally prepared, don’t do it.
More Security Issues – Security issues surrounding cryptocurrencies have been well highlighted. Total value lost from the various hacks is more than half a billion dollars. However, most exchanges have greatly improved their security. Further, options such has hardware wallets are a very safe way to store your cryptocurrencies.
Ethereum is the second most popular cryptocurrency after Bitcoin. While it remains far cheaper than Bitcoin, at $449 as of Dec 2017, that is still a gain of more than 50x since January! Nevertheless its cheaper price means that many investors are looking at it as one of the most viable Bitcoin alternatives. There is also one important difference between the two that may make an Ethereum IRA more suitable for you.
Ethereum is also a blockchain platform that facilitates peer-to-peer contracts and applications. These ‘smart contracts’ are stored on the decentralized blockchain, which makes verification easy and fraud difficult. Decentralized is the key word, with all smart contracts replicated on every computer in the network. A common analogy in the crypto-community is ‘Bitcoin is digital gold while Ethereum is digital oil’. You can even create your own cryptocurrency on the Ethereum network (which many have).
This is the main feature that differentiates Ethereum from the other cryptocurrencies. It is also the one that appears to have the most long term applications. Because of this, long term investors i.e. those investing for retirement, may benefit more from an Ethereum IRA over a Bitcoin IRA. For more on Ethereum vs. Bitcoin, check out this article.
Investing in cryptocurrency itself can seem daunting to a newbie. So investing in cryptocurrencies via an IRA may seem even harder. Here’s an easy way and a more complex one.
In the DIY version, you have to set up an LLC (for IRS compliance purposes). Your IRA custodian will hold this LLC as its asset. Although not technically the owner, you are the manager and thus choose how to invest the funds. From there, you can set up an account on the cryptocurrency exchange of your choice. But make sure that the account is set up under the LLC’s name.
Finding a cryptocurrency exchange that allows you to register an account under an LLC can be difficult. Further, if you decide to hold the cryptocurrency in a hardware wallet (recommended for larger amounts), make sure that the LLC owns the wallet. You can do this by using a debit card linked to the IRA’s checking account to purchase said wallet.
Does the above sound too complicated for you? If so, you can consult IRA custodians that specialize in cryptocurrency IRAs. These companies will guide you through the entire process with minimal hassle. Two popular companies offering cryptocurrencies today are Bitcoin IRA and Regal Wallet.