Founder/CEO of Next Generation Trust Company, a trust company specializing in custodial & administrative services for Self-Directed IRAs.
Cryptocurrency and digital assets are intangible and can be difficult for many people to understand. However, investors who fully grasp how cryptocurrency works and wish to invest in this alternative asset through their retirement plans may do so with a self-directed individual retirement account (IRA).
Digital assets may be used as an alternative to government-backed currency by people who don’t have access to traditional banking or those who wish to conduct anonymous transactions swiftly with what amounts to digital tokens. The top cryptocurrencies have seen incredible gains already this year. As of February 20, the total value of all cryptocurrencies was almost $1.8 trillion, and the market cap of Bitcoin hit $1.2 trillion.
Bitcoin, the most well-known and largest cryptocurrency, entered the market in 2009. What is peculiar to Bitcoin is that the quantity to be produced was designed to cap at 21 million, so it is a limited asset to a certain extent. As of February 24, it was valued at over $49,000, so anyone holding it is sitting on a valuable asset.
Other names in the cryptocurrency market include Ether, Litecoin, Cardano, Polkadot and Monero. However, there are many more.
The Tech Behind Crypto
Cryptocurrencies are created by blockchain technology (Bitcoin was the first to be produced by blockchain). This technology is decentralized; there is no intermediary, no government entity and no financial institution involved. Blockchain enables peer-to-peer financial transactions across a distributed ledger network: a chain of computers worldwide that “mine” the digital currency. Each transaction is represented in a block. The miners mine the block, and nodes create the ledger, which cannot be changed. Every node holds a copy of every transaction; a competing copy would be recognized by the network as invalid. This distributed network makes for safe, transparent transactions.
Investing In Cryptocurrency With An IRA
Individuals with a self-directed IRA may include cryptocurrency in their retirement portfolio; however, doing so is a bit different than many other self-directed investments. Some investors buy Bitcoin to hold in the same way, and for the same reasons, as gold or other precious metals, which are also allowable investments within a self-directed IRA.
In the case of cryptocurrencies, anyone who wants to buy or trade digital assets must do so through a digital wallet (an app), which is linked to a checking account. The investor must also create an account on one of the trading exchanges or purchase assets through brokers.
To hold cryptocurrency in a retirement account, the account owner must make the investments through an LLC (limited liability company). The steps to take are as follows:
1. Establish and fund a self-directed IRA with a custodian of such retirement plans.
2. Form and register an LLC, which will be 100% owned by the IRA and, therefore, carry the same tax-advantaged status as the IRA. The income and expenses related to the assets will flow through the IRA LLC as required by the Internal Revenue Service. Cryptocurrency is considered property for federal tax purposes by the IRS, but because the assets are owned by a retirement account, gains are tax advantaged.
3. Using funds from the IRA, the LLC opens a business checking account (an IRA LLC is also referred to as a “checkbook IRA”). The checkbook puts the account owner in full control of the transaction (checkbook control), which is made simply by writing a check or wiring funds. The funds in the IRA LLC’s business checking account are for the sole purpose of investing in the digital assets (or any other alternative assets allowed through self-direction).
4. Open an account on a cryptocurrency exchange in the name (and tax number) of the IRA LLC. In addition to being purchased or traded on exchange platforms, digital assets may also be purchased through brokers or by investing in a fund that holds various digital currencies through private placement. In effect, the IRA purchases shares or directly invests as a limited partner.