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George F. Bearup, J.D. Senior Legal Trust Advisor

27-Jun-22

Cryptocurrency in IRAs

Take-Away: Cryptocurrency can be held in an IRA. But should they be a viable IRA investment?

Background: A few months back, the Department of Labor expressed some concern in one of its publications with regard to holding cryptocurrency in a qualified retirement account. More recently, Fidelity Investments made the news by announcing that it would begin to permit Bitcoin to be held as an investment in 401(k) accounts administered by Fidelity. As a result, employers that sponsor qualified plans now need to decide to offer Bitcoin as an investment option in the 401(k) plans that they sponsor. Many plan sponsors will probably take a ‘pass’ in light of the liability concerns associated with a speculative investment option in a plan of which the employer is a fiduciary.

IRAs: However, unlike qualified retirement plans, there is no ‘gatekeeper’ for an IRA and its investments. Other than a short list of prohibited investments that cannot be held in an IRA, e.g. life insurance; coins; rugs; antiques; collectibles; almost any type of asset can be held in an IRA, presumably including cryptocurrency.

Pros and Cons: Whether to hold cryptocurrency as an IRA investment comes down to balancing all of the following factors.

  1. Reward v. Risk: Obviously, just by watching the news, there could be considerable upside to investing in cryptocurrency inside an IRA, particularly if a Roth IRA holds the cryptocurrency, since all earnings in a Roth IRA can be distributed tax-free (assuming the 5-year holding rule is followed.) Then again, there is considerable risk associated with investing in cryptocurrency (where there are few rules and regulations and very little historical track record) when you consider that the retirement funds are supposed to actually be available when the account owner  retires. That risk is why some investments are perceived to be too illiquid and speculative, e.g. artwork; collectibles, and are thus expressly prohibited as IRA investments in the Tax Code.
  2. Cash Contribution: Property cannot be contributed to an IRA- only cash can be contributed to the IRA. Accordingly, other assets will have to be liquidated, and gain (if any) recognized, in order to create the cash that can then be used to fund the IRA. The IRA then purchases the cryptocurrency using that cash. Often overlooked is the possible tax incurred to create the cash needed to fund the IRA. Restated, if the account owner already owns cryptocurrency, that cryptocurrency cannot be directly contributed to the IRA.
  3. Careful Custodians: Not all IRA custodians will agree to allow cryptocurrency to be held in IRAs that they administer. A few IRA custodians now advertise that they will accept cryptocurrency as an IRA investment, but not all IRA custodians are ‘jumping on this bandwagon.’ Some search may be required to find a IRA custodian that is willing to ‘hold’ that investment (when, arguably, there is nothing to ‘hold’ if cryptocurrency is the asset.)
  4. Annual Valuations: The IRS requires an annual valuation of the IRA and the assets that the IRA holds. Cryptocurrency values are extremely volatile and according to some sources, not all that reliable. This annual valuation and tracking of a hard-to-value asset can be expected to create more administrative hassles, and probably lead to higher custodial fees.
  5. RMDs: Like with the annual valuation drawback, the same can be said if cryptocurrency his held in the IRA when annual required minimum distributions (RMDs) must be taken by the account owner. When valuations are sketchy,  failing to take the correct amount as an RMD could expose the account owner to the 50% excise tax on the excess RMD amount that was not taken by the IRA owner.

Conclusion: Adding diversity to a retirement account’s investments makes sense, and cryptocurrency might provide that desired diversity, maybe in small doses. However, the administrative issues encountered along the way, in addition to the high degree of speculation associated with cryptocurrency, should give any investor who is saving for retirement pause, to think twice. If possible, it would be best to hold the cryptocurrency in a Roth IRA, along with other less speculative investments.