Pros and Cons of Investing in Bitcoin IRAs

What Are Bitcoin IRAs?
There is not a specific Internal Revenue Service (IRS) account designed for cryptocurrencies. Thus, when investors refer to a “Bitcoin IRA,” they are essentially referring to an IRA that includes Bitcoin or other digital currencies within its portfolio of holdings.

Since 2014, the IRS has considered Bitcoin and other cryptocurrencies in retirement accounts as property, meaning coins are taxed in the same fashion as stocks and bonds.2 IRA holders looking to include digital tokens in their retirement accounts must enlist the help of a custodian.

Individuals may find that including Bitcoin or altcoin holdings may add diversification to retirement portfolios. This may help to protect those retirement accounts in the event of a major market downturn or other tumultuous activity in the future.

Perhaps more than diversification, investors inclined to add Bitcoin holdings to their IRAs likely believe that cryptocurrencies will continue to grow in popularity and accessibility into the future. With their long-term outlook, IRAs are an excellent vehicle for investments that hold major potential on the scale of decades. Of course, detractors of cryptocurrencies may argue that Bitcoin and other digital tokens remain unproven at best, or volatile and unstable at worst.

For those determined to invest in Bitcoin, it may be possible to avoid hefty capital gains taxes by including digital currencies in certain types of retirement accounts. However, there are other fees to consider as well, as we’ll see below.

Bitcoin’s extreme volatility in recent years makes it a tough sell as a retirement investment for many. The leading cryptocurrency routinely experiences significant price fluctuations; following a record price at the time of over $16,000 per bitcoin in December 2017, the price plummeted. Its price, however, recovered over the next several years, reaching record highs in 2021.3 While Bitcoin’s price has risen over time, its price volatility could be unsuitable for somebody approaching retirement who cannot afford to ride out a downturn.

Worse, pessimists would likely argue that the hype surrounding Bitcoin and digital currencies as a revolutionary new form of currency has so far proven to be dramatically exaggerated. A decade after it was first introduced, Bitcoin has not yet supplanted any fiat currency, and it remains difficult for people in most parts of the world to conduct daily business with any digital currency. In 2021, the nation of El Salvador passed a law making Bitcoin legal tender alongside the U.S. dollar.4 Time will tell if greater adoption follows in the terms of use of Bitcoin in exchange as money.

Another key disadvantage of including Bitcoin in an IRA is the fees. Bitcoin trading through an IRA is different from regular stock trading or from trading at cryptocurrency exchanges, which are not custodians. The potential tax benefits of trading Bitcoin through a self-directed IRA account come with their own set of challenges. The most important of these is the expense of added fees and risk. Because firms offering self-directed IRA services are not bound by broker fiduciary duties, investors are on the hook if they do not assess risks associated with crypto markets.

Fees for Bitcoin trading take on various forms during the investment process, from initial setup fees to custody and trading fees to annual maintenance fees. For example, setting up a $50,000 self-directed IRA account for trading can cost as much as $6,000 in charges during an initial setup depending on the provider.5 There are also recurring custody and maintenance fees charged by providers of such services.

Finally, each cryptocurrency trade also incurs its own set of fees from the service provider’s trading partner and custodian. A typical provider may charge 3.5% per transaction for each purchase and 1% or a flat fee for each sale. Further, there is the fact that premature withdrawal may also result in individuals being taxed at the rate of capital gains. Cumulatively, those fees could negate the tax advantages offered by IRA accounts.