The IRS allows self-directed IRAs to invest in certain physical assets and property if they’re held by an approved custodian. The agency issued guidance in 2014 noting that for federal tax purposes, virtual currency would be treated as property, which would seem to open the door for investors who want to use an IRA to invest in cryptos.
The question is, just because they can, does that mean they should?
“There’s no question that investing in digital currencies is highly speculative. We are in the early days of the Wild West, and it is very difficult to determine with any degree of confidence what’s going to happen to any of the digital currencies,” Ric Edelman, chairman and co-founder of Edelman Financial Services, told ThinkAdvisor.
(Related: Will Bitcoin Ever Be a Fiduciary Asset?)
He pointed out that there are over 800 digital currencies currently, though it’s impossible to say which of the current tokens will prevail.
“We don’t know which platform is going to survive. We don’t know what governments around the world are going to do, or central banks around the world. They may create their own fiat digital currency.”
The Reserve Bank of India is looking into doing just that, the Economic Times reported in mid-September. The publication quoted RBI Executive Director Sudarshan Sen, who said at a recent India Fintech Conference, “Right now, we have a group of people who are looking at fiat cryptocurrencies. Something that is an alternative to the Indian rupee, so to speak. We are looking at that closely.”
Meanwhile, China has banned the use of initial coin offerings to raise capital and plans to ban trading of Bitcoin and other digital currencies, Bloomberg reported.
These are all challenges that advisors should address with their clients if they’re thinking about sinking retirement assets in cryptocurrencies.
One company is trying to make it easier for audacious investors who want to cash in on the growth potential of digital currency.
Bitcoin IRA is a self-directed IRA platform that lets users transfer existing retirement assets to an approved IRA to purchase certain cryptocurrencies, including Bitcoin and Bitcoin Cash, Ethereum and Ethereum Classic, Ripple and Litecoin. The tokens are held by custodian Kingdom Trust and stored in a BitGo cold storage wallet that requires three security keys to gain access.
Chris Kline, chief operating officer of Bitcoin IRA, believes that cryptocurrencies are very similar to gold as a way to insulate portfolios from wider economic forces.
“There are some [investors] who are looking for yield,” he told ThinkAdvisor. “They’re at that point in their retirement where they need to start growing and accruing. Others are getting out of dollar-based assets for fear that [the] dilution and hyperinflation that’s happening in other places could strike here; a lot of the same parallels to gold buyers, but instead of a brick of gold that you store, it’s a cryptocurrency. Bitcoin in particular is [considered] Gold 2.0 because of the store value of it; it’s so limited and finite in its nature.”
Bitcoin supply is capped at 21 million BTC.
Kline said his customers include people who are experimenting with digital currencies and those who are doubling down on their growth potential.
“We’ve had people who have just gotten started with a small amount, 1% or so, of their portfolio in cryptos and then slowly accrue more of that over time in additional trades or as different coins become available,” he said.
Kline acknowledged that cryptocurrencies are a speculative and volatile asset, so “it’s something that [this] group of people in particular [should] move slower and more tactfully” toward in their investments.
However, he said there’s also “a large number of people who put all of their 401(k)” onto his platform. “We’ve had clients who have even left jobs so that they can liberate their old 401(k)” from traditional assets on those platforms.
Those investors “are usually a little bit younger in age, 30s, 40s, … but we’ve also had significant investments from people in their late 60s and early 70s and are taking in-kind distributions of the cryptocurrencies from the retirement plan to fulfill their RMD,” he said.
Kline said that his customers are fairly evenly spread across age groups, though “50 to 65 is a big peak” in the ages of account holders. Ultimately, “it’s for each [investor's] own interest and seeking of yield, and appetite for risk.”
Weighing the Odds
In spite of the myriad drawbacks to cryptocurrency purchases, Edelman believes digital currencies are worth investors’ time — just not their retirement dollars, perhaps.
“There are a significant number of uncertainties. All of that said, there is in my view no doubt that digital currencies are the future,” he said. “Today it appears likely — [I] emphasize today — that Bitcoin and Ethereum are the most likely candidates to succeed, but that could easily change tomorrow. Ethereum didn’t exist six months ago.”
He compared digital token supremacy to the airline industry.
“It’s like saying that we have confidence that the airline industry is here to stay, but that doesn’t mean that Delta is. If you go back to the 1950s and ’60s, the biggest airlines were Panam and Eastern. Neither one of those airlines exists today, but the airline industry is bigger than ever.”
Edelman believes “it does make sense to own digital currencies in your portfolio,” but that they should be treated as “lottery tickets.”
“You don’t need to have much — 1% of your portfolio is more than enough — [and] like lottery tickets, odds are high it isn’t going to succeed.”
While digital currencies may be appropriate for some clients, Edelman wouldn’t recommend an IRA as an investment vehicle, “not only because of the risk issue,” he explained, but because clients could end up with a big tax burden.
“If Bitcoin proves profitable, or any digital currency you choose to invest in, the profits will be subject to capital gains [tax] rates. If you put them inside an IRA, you now are stuck with ordinary income rates, which are twice as high,” he said.
— Read Crypto Bill Could Ease Tax Burden on Bitcoin Transactions on ThinkAdvisor.