The Internal Revenue Service (IRS) does not recognize a distinct Individual Retirement Account (IRA) made for cryptocurrencies. Therefore, when someone talks about a “crypto IRA” or “Bitcoin IRA,” they are talking about an IRA that includes digital currencies within its portfolio.
According to the IRS 2014-21 Notice, cryptocurrencies are taxed as property. This means they are taxed the same as bonds, stocks, and other investment types. However, cryptocurrencies cannot be placed in an IRA by the retirement account holder. This indicates that an account holder needs a custodian if they want to place crypto in their IRA. And finding a custodian can be a challenging task.
Luckily, self-directed IRAs (SDIRAs) allow alternative assets such as cryptocurrencies. Custodians are designed to aid investors to include crypto in their IRAs, which are becoming increasingly popular. While investing in a crypto IRA has its benefits, we cannot ignore the volatility of the crypto market, making it a risky investment.
So, to help you decide whether to invest in a crypto IRA or not, let's first understand the pros and cons of investing in a crypto IRA.
How Does Cryptocurrency IRA Work
As the name implies, it is a self-directed retirement account that allows you to invest in cryptocurrencies.
The minimum requirement to set up a new crypto IRA account is between $250 and $395. This setup fee is further deductible from the amount that you transfer over to your new IRA. Additionally, since it is a retirement account, you’ll be subjected to tax penalties if you withdraw funds early. If you withdraw money before you reach 59 ½, you’ll have to pay an early withdrawal fee, which is usually 10 percent, and income tax.
The Pros of Cryptocurrency IRAs
The Outweighing Growth
Investors willing to add crypto to their IRAs believe that cryptocurrencies will keep increasing in value, popularity, and accessibility. With the ability to provide value in the long term, IRAs are excellent investment vehicles. The potential of growth coexists with the risk of losses, but many investors believe that the growth potential outweighs the risks.
Investing in a crypto retirement account is still a new idea and it’s only offered by a few specialty providers such as Bitcoin IRA, iTrustCapital, Coin IRA, and more. However, you can add crypto to your investment strategy for retirement with a crypto IRA as traditional IRAs only focus on standalone mutual funds or target funds. One thing to remember is that all IRAs are not crypto IRAs. Traditional IRAs are not yet equipped to offer direct investments in cryptocurrencies.
By adding crypto holdings to your retirement portfolio, you diversify it. This diversification protects your retirement account when particular cryptocurrency tanks or other ups and downs in the future.
Tax Deferred Crypto Investing
Including cryptocurrencies in retirement accounts is a brilliant way to avoid hefty capital gains taxes. For instance, if you put crypto in a Roth IRA, it allows you to realize capital gains without taxes because you already paid taxes on the funds in your account.
When you put cryptocurrencies in a regular IRA, you are liable to pay income taxes upon withdrawal of funds. It could benefit from a tax perspective if your income is lowered after withdrawals from the IRA.
Next on the list of pros and cons of investing in a crypto IRA are the cons.
The Cons of Cryptocurrency IRAs
The Price Instability
Crypto-day traders thrive on the volatility of the market, but for retirement investors, the same volatility puts crypto at a disadvantage. For instance, Bitcoin, the first ever cryptocurrency, experiences significant price fluctuations regularly. From $69,000 last year, it came down to $20,000 this year. This extreme volatility makes it unsuitable for many investors to include it in their IRA.
Volatility brings the risk of loss. For instance, if you invest $1,000 in a cryptocurrency, its value could drop by 80 percent and never recover. Here, you’d lose $800. Similarly, a larger investment would amplify the losses.
A lot of cryptocurrencies aren’t backed by assets or businesses. So, investors or the public may lose interest in them after your purchase. Also, a lot of crypto tokens run on faith that they are worth something. If this faith waiver, crypto tokens could collapse completely.
The Fees Involved
One of the cons in our list of pros and cons of investing in a crypto IRA is the fees. There are several charges you might have to pay during the investment process such as initial setup fees, annual maintenance fees, and custody and trading fees, among others.
For instance, if you want to set up a $50,000 self-directed IRA for trading, you may end up paying several thousand dollars in fees for an initial setup depending on the provider. These service providers may also charge you recurring custody and maintenance fees.
Crypto investments have unique requirements such as custody and security, which increase the fees for services offered by IRA accounts. IRA investors may also pay for the additional reporting duties done by the IRA custodians to the IRS.
Final Thoughts on Pros and Cons of Investing in a Crypto IRA
Crypto IRA is one of the best ways to save some taxes and diversify your retirement portfolio. But it comes with a set of pros and cons, which we discussed in this guide. For investing in a crypto IRA, we recommend consulting a certified financial advisor well-versed in cryptocurrency to make sure your money is put to its best use.