In the past year, cryptocurrency has gained widespread popularity, and the price of bitcoin, which has the highest market value, reached an all-time high in April.
Given the buzz around it, you might be pondering the feasibility and benefits of investing in cryptocurrency for your retirement, particularly in your IRA.
While it is feasible to use a self-directed IRA to keep unconventional investments like real estate or commodities that are usually not allowed in a conventional IRA, it is generally advised against by professionals.
It is advisable to steer clear of cryptocurrency as a retirement investment.
‘The costs can be sizable’
One reason experts warn against investing in cryptocurrency through a self-directed IRA is because they’re not widely available and don’t make sense for most investors. Generally, they can be both risky and expensive to maintain, even without cryptocurrency holdings.
The Internal Revenue Service has implemented stringent guidelines on the types of investments that are not allowable in IRAs. In the case of a self-directed IRA, you are responsible for overseeing all of your investments, meaning that any failure to comply with the regulations would be your personal liability.
“Self-directed IRAs usually require a specialized firm or custodian and the costs can be sizable due to the additional compliance and IRA requirements,” Anjali Jariwala, certified financial planner, certified public accountant and founder of Fit Advisors , tells CNBC Make It. “[I]f you fail to abide by all of the rules, then your account may lose its tax-deferred status.”
The SEC has cautioned about the possibility of fraudulent activities, associated with self-directed IRAs that offer a wider range of investment options. In 2018, the SEC stated that investors should exercise caution when investing in such IRAs, as they carry a higher risk of fraudulent schemes, exorbitant fees, and unpredictable performance.
Jariwala expresses that he or she would have significant unease about another person’s choice to move forward.
Crypto has its own risks
Jariwala cautions that investing retirement funds in cryptocurrency carries even more risk than a self-directed IRA, given its unstable and uncertain nature.
Investors who choose to invest in cryptocurrency must be prepared for significant fluctuation in prices and the possibility of losing their entire investment, which is why including crypto in a retirement portfolio may not be advisable. Instead, it may be more prudent to allocate a small portion of the portfolio to crypto as it has the potential to considerably increase the risk profile and potential drawdowns of the overall portfolio.
“I believe in diversification and prefer IRA-type accounts to be invested in the markets,” Jariwala says. “If [an investor has] extra money that is in cash or sitting in a brokerage account, that may be used toward more speculative investments like bitcoin, but I wouldn’t try to find a way to invest retirement money.”
It’s crucial to contemplate the likelihood of further regulations surrounding cryptocurrencies prior to incorporating them into your self-managed IRA.
“Currently, crypto is viewed as property, but if the IRS changes the asset type, it may become one that cannot be held in a self-directed IRA,” Jariwala says. If that happens, “you might be stuck and forced to liquidate at an unfavorable time or face severe tax issues.”
In case you remain interested in investing in cryptocurrency despite the potential dangers, consider beginning with an amount that does not affect your retirement savings – this will enable you to bear the risk. By allocating a minor percentage of your total portfolio, you can minimize the risk and simultaneously gain cryptocurrency asset exposure.
Are Crypto and Retirement Savings a Risky Mix?
Investor interest in cryptocurrencies hasn’t dwindled despite their significant drop in value this year. This interest is so strong that certain 401(k) plans could soon allow for Bitcoin investments. However, the fact that Bitcoin can be used as a retirement savings investment doesn’t necessarily mean it’s a good idea.
“Cryptocurrencies are still relatively new, largely unregulated, and very volatile, which isn’t a great mix for a traditional long-term portfolio,” says Rob Williams, managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research. “Think of your retirement savings as the foundation of your financial house. You want to build your foundation out of strong, trusted materials.”
This implies putting money into established asset categories such as stocks and bonds, where a history of sustained development potential is evident and their valuation is influenced by assets, profits and other measurable criteria.
“These securities are tied to the intrinsic value of their underlying companies, whereas cryptocurrencies do not yet have such inherent value,” Rob explains. “And, unlike fiat currencies, cryptocurrencies aren’t backed by the full faith and credit of a government—they’re worth only what others in the market are willing to pay for them.”
The issue of taxes must also be taken into account. Should the value of the cryptocurrency in a conventional 401(k) or IRA increase, the resulting gains will be subject to regular income taxes when withdrawn. On the other hand, if the crypto assets are held in a taxable account for more than a year, they will be subject to the more favorable long-term capital gains tax rates of 0%, 15%, or 20%, depending on one’s income. (No taxes will be imposed on any gains from crypto investments within a Roth 401(k) or a Roth IRA.)
Additionally, losses incurred from cryptocurrency holdings in retirement accounts cannot be utilized to counterbalance income or realized gains, unlike taxable accounts. As cryptocurrencies are susceptible to fluctuations in value, one may want to employ losses to their advantage – another reason why speculative trading is ill-suited for retirement accounts, according to Rob.
Although early investors have made profits from some cryptocurrency investments, countless others have suffered losses. Rob advises that if one intends to participate in cryptocurrency investments, it should be done with caution, and keeping their retirement savings far away from it.
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