Bitcoin and other cryptocurrencies have attracted their fair share of day traders, swing traders, and position traders, but long-term investors have also taken an interest in the growing digital currency asset class. Many long-term investors use their individual retirement accounts (IRA) due to their unique tax advantages and the long-term focus compared to short-term traders.
Let’s take a look at how investors can hold Bitcoin and other cryptocurrencies in individual retirement accounts, as well as some important considerations to keep in mind.
Cryptocurrency IRA: What Really Is A Crypto IRA?
Individual retirement accounts, or IRAs, make it easy to save for retirement with tax-free growth or on a tax-deferred basis. While many people save through employer-sponsored plans, such as 401(k)s, IRAs tend to have more flexibility and provide supplemental savings. These IRAs are available through banks, brokers, and even robo-advisors.
There are two main types of IRAs:
- Traditional IRAs: You make contributions with money that you can deduct on your tax return and any earnings grow tax-deferred until you withdraw them in retirement. Since many retirees are in a lower tax bracket than they were prior to retirement, deferring taxes often translates to a lower tax bill.
- Roth IRAs: You make contributions with money that you already paid taxes on and the money grows tax-free rather than tax-deferred. The subsequent withdrawals are also completely tax-free. While Roth IRAs involve more upfront cost, the long-term tax savings can be significant, particularly if assets appreciate in value.
SEP and SIMPLE IRA Accounts
If you are self-employed or work for a small business, SEP and SIMPLE IRAs are two other types of IRA accounts. Both of these accounts are similar to traditional IRAs in that contributions are tax-deductible, but unlike traditional IRAs, there are higher contribution limits, and small businesses may have to contribute a match to the employee’s contribution.
There are many different rules associated with IRA, including limitations on the types of assets that can be held. For instance, most IRAs don’t allow cryptocurrency investments and primarily focus on stocks, bonds, and funds. The notable exceptions with regards to cryptocurrency IRA are crypto-focused funds that provide exposure to cryptocurrencies through a conventional fund structure.
What is a Self-Directed IRA?
A self-directed IRA, or SDIRAs, provides additional flexibility for sophisticated investors that wish to hold alternative assets—including crypto IRA, real estate, gold bullion, and other alternative assets. That said, the IRS imposes some limitations on the types of eligible assets, prohibiting things like life insurance policies and collectibles.
Like a conventional IRA, SDIRAs is administered by a custodian or trustee and can be classified as either a traditional or Roth IRA. The key difference is that they are managed by the account holder (“self-directed”) and custodians aren’t allowed to give financial advice. That’s why most traditional brokers and banks don’t offer these types of accounts.
There are also several risks to keep in mind with regard to self-directed IRA:
- Breaking the Rules. Conventional IRA providers will ensure that you’re following the rules, but with SDIRAs, the entire account could be distributed to you with taxes and penalties if you break the rules. It’s up to you to understand them.
- Higher Fees. SDIRAs or self-directed IRAs tend to have more complex fee structures, including one-time, first-year, annual, and investment fees. You should take the time to understand these fee structures in order to avoid having them eat into your returns.
- Liquidity. Stocks, bonds, and funds have enough liquidity to quickly enter and exit investments at a good price. On the other hand, alternative assets can be a lot more illiquid, including lesser-known cryptocurrencies.
- Fraud. SDIRA custodians can provide a wide range of different assets, but since they aren’t allowed to provide financial advice, it’s up to you to determine the worthiness of the investments and avoid any scams.
There are many different SDIRA custodians that provide access to cryptocurrencies, including Bitcoin IRA, Coin IRA, iTrust Capital, Bit IRA, Equity Trust Company, Regal Assets and others. When evaluating different custodians, you should take the time to understand the available investments, fee structures and other account attributes.
Should I Invest in Crypto With An IRA?
There are many different ways to invest in cryptocurrencies. While purchasing them outright is a popular option—and SDIRAs provide a tax advantage when doing so, there are also a number of conventional funds that make it possible to hold crypto assets without worrying about buying and selling the actual cryptocurrencies—although there’s a fee involved.
It’s also important to keep the tax implications of cryptocurrency investing in mind. The International Revenues Service (IRS) treats cryptocurrencies as property, which means that they are subject to capital gains tax when exchanged or sold. When investing in crypto with IRAs, the tax treatment depends on whether the account is a traditional or Roth IRA.
Traditional IRAs let you deduct the amount that you contribute to the IRA from your taxes in the current year, but you owe taxes on the amount when you withdraw the cryptocurrency in retirement. On the other hand, Roth IRAs involve paying taxes on the contributions in the current year and then not worrying about any taxes when withdrawing in retirement.
One interesting feature of cryptocurrencies is that they aren’t subject to the same wash-sale rules as equities. If a cryptocurrency falls in value, an investor can sell the asset to realize the loss in the current tax year and immediately repurchase it to maintain their portfolio allocations. These tax loss harvesting strategies can significantly improve after-tax returns.
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Checklist of Crypto IRA Providers
Use the following checklist of crypto IRA providers to help decide on the best option for your retirement savings.
The Bottom Line
Individual retirement accounts, or IRAs, are a popular way to save for retirement in a tax-advantaged way. While most conventional IRA providers don’t permit crypto assets, self-directed IRAs, or SDIRAs, make it easy to own crypto IRAs. However, it’s important to take the fees and other factors into consideration when choosing a custodian account.
ZenLedger easily calculates your crypto taxes and also finds opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!
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