Interest in crypto has surged over the past several years, with 3 in 5 people believing it’s a strong long-term investment. Generally speaking, however, most people won’t have access to cryptocurrencies via their employer’s workplace plans like 401(k)s..
Enter the crypto IRA. Mechanically, crypto IRAs have many of the same rules associated with your run-of-the-mill traditional or Roth IRAs, but offer the chance to invest in digital assets. Depending on your provider, you’ll have access to the major coins, like Bitcoin, Ethereum, and Litecoin, and you may even have access to some of the alt-coin universe as well.
Here, we’ll discuss the pros and cons of opening a crypto IRA.
The pros of investing in a crypto IRA
- Access. This is probably the most visible benefit. The chance to invest in cryptocurrency in a retirement account is still a very new idea, and it’s currently only offered by specialty providers. But if you’re looking to add cryptocurrency to your investment strategy for retirement, you’ll only be able to do so through a crypto IRA as most 401(k), 403(b), and 457(b) plans only offer standalone mutual funds or target date funds as part of their respective investment menus. However, not all IRAs are crypto IRAs. The standard traditional and Roth IRAs offered by the most popular online providers aren’t yet equipped to offer direct investments in cryptocurrency.
- Potential diversification. Some investors look to cryptocurrency as a means of diversifying their overall portfolio. According to a study by researchers at Yale University, there may be a diversification benefit to adding crypto – even a 6% portfolio allocation to Bitcoin can make your portfolio more efficient. That said, it doesn’t mean you’re doing anything wrong if you have a portfolio of index-tracking ETFs and mutual funds. Adding Bitcoin is a personal preference, based on where you stand on the risk-reward spectrum.
- Tax benefits. Because crypto IRAs can be opened as either a traditional or Roth IRA, they enjoy many of the same tax benefits. For instance, in either type of account, capital gains are shielded from taxation so long as the money remains in the account. This is a major upgrade from holding cryptocurrency in a taxable wallet, where capital gains are taxed any time you sell an asset at a gain. If you expect outsized crypto gains, you may be better off holding them in a crypto IRA – particularly a Roth crypto IRA. Another benefit of Crypto is that unlike most other assets, you’re able to “stake” it to earn interest and other rewards. Any income earned via staking is typically taxed as it’s earned, but the crypto IRA eliminates this concern. Inside the walls of a crypto IRA, any regular income earned and received is shielded from taxation. You’ll still need to pay attention to tax status when it comes to deciding on traditional vs Roth crypto IRA. Recall that traditional IRAs are typically used as “pre-tax” retirement vehicles, meaning that taxation occurs at ordinary rates when you withdraw money from the account. Roth IRAs, on the other hand, hold after-tax money that grows tax-free until the death of the account holder.
The downsides of investing in a crypto IRA
- Volatility. Crypto is generally believed to be more volatile than traditional asset classes such as stocks & bonds. As such, it’s smart to balance your allocation to cryptocurrency with your need, ability, and willingness to take risks. As people approach retirement, their willingness to take risk tends to drop rapidly, so the idea of holding a volatile asset may be unappealing to many pre-retirees and retirees alike. At the same time, this volatility is viewed as a positive by some investors – high risk can mean big rewards (or big losses).
- Unproven asset class. Given that crypto is a relatively new asset class, some experts question their effectiveness as investments. Unlike equity shares, Bitcoin and other cryptocurrencies have no underlying earnings and no related cash flow. Hence it’s hard to get a true valuation for these assets.
- Limited utility. Even though Bitcoin is increasing in adoption, it does have limited utility as far as paying for goods and services in today’s economy. Bitcoin transactions take place on the blockchain, a distributed ledger that aims to make payments faster and cheaper.