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Investing in Cryptocurrency With a Self-Directed IRA

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SmartAsset: Investing in Cryptocurrency With a Self-Directed IRA

Cryptocurrency can add diversification to your portfolio. Your brokerage may allow you to trade digital currencies through a taxable account but you could also use a self-directed IRA to invest in crypto for retirement. A self-directed IRA doesn’t follow the same rules as a traditional or Roth IRA. If you’re considering a self-directed IRA for cryptocurrency investing, it’s important to understand how they work.

A financial advisor could help you create a financial plan for your investment and retirement needs.

What Is a Self-Directed IRA?

A self-directed IRA is an Individual Retirement Account that allows for tax-advantaged saving while giving you control over your investments. You can set up a self-directed IRA that follows traditional or Roth IRAs for contributions, withdrawals and taxation.

For example, you can contribute up to $6,000 to a self-directed IRA for 2022. The limit increases to $7,000 if you’re 50 or older. Contributions to a traditional self-directed IRA can be tax-deductible. Qualified withdrawals from a Roth self-directed IRA would be tax-free. The difference between a self-directed account and other types of IRAs is what you can use them to invest in.

Can You Have Cryptocurrency in an IRA?

Yes, you can own cryptocurrency inside a self-directed IRA. When you open a regular IRA, traditional or Roth, your investment options might include stocks, mutual funds, index funds, exchange-traded funds and bonds. A self-directed IRA, on the other hand, allows you to choose from a broader range of investments, including:

  • Real estate or undeveloped land
  • Real estate notes and promissory notes
  • Precious metals
  • Tax lien certificates
  • Water and mineral rights
  • Cryptocurrency

Contributions to a traditional self-directed IRA can be tax-deductible. Qualified withdrawals from a Roth self-directed IRA would be tax-free. There are some rules, however, for contributing to a self-directed IRA for cryptocurrency or other investments.

Self-Directed IRA Rules

If you’re considering a self-directed IRA for cryptocurrency trading, there are three rules to be aware of. These rules relate to how you can use the account to invest in order to enjoy the tax-advantaged status of an IRA.

First, there’s a rule against disqualified persons. You can’t engage in transactions with anyone the IRS considers to be a disqualified person, which can include:

  • Yourself
  • Your IRA beneficiaries
  • Any of your family members
  • Your financial advisor
  • Any entity that a disqualified person has a 50% or greater ownership stake in
  • Anyone who works for a disqualified person in an executive role, as a highly compensated employee or is a shareholder of their company

Next, you can’t use a self-directed IRA to engage in transactions for personal benefit. So you couldn’t take income generated by self-directed IRA assets, such as cryptocurrency, and redirect it to a personal bank account. All income created by the IRA has to stay in the IRA.

Finally, you can’t use a self-directed IRA to invest in disallowed assets. Disallowed assets include things like life insurance policies and collectibles or antiques. Again, violating any one of these rules could cause your self-directed IRA to lose its tax-advantaged status.

Using a Self-Directed IRA for Cryptocurrency Investing

SmartAsset: Investing in Cryptocurrency With a Self-Directed IRA

To use a self-directed IRA for cryptocurrency trading, you’ll first need to choose a custodian. This is the brokerage or entity that will hold your self-directed IRA funds. If you already have a taxable trading account at an online brokerage, you could check there to see if self-directed IRAs are also offered.

If not, you’ll need to look for another custodian but the good news is, there are plenty of companies that specialize in self-directed IRA services. You’ll specifically need to look for a self-directed IRA custodian that offers cryptocurrency as an investment option.

Once you select a custodian, you’ll need to complete the paperwork to open your account. You’ll also need to link a bank account to deposit funds so you can start making investments. At this stage, your IRA custodian may open an account for you on a cryptocurrency exchange or request that you set up this account yourself. Depending on the brokerage, you may also need to set up a limited liability company (LLC) before you can start making cryptocurrency investments with your IRA.

The next step is deciding what types of cryptocurrency you’d like to invest in. This can depend on what’s offered through your crypto exchange and your personal preferences. It’s also important to consider how much of your self-directed IRA you want to dedicate to crypto trading in order to maintain an appropriate level of diversification.

Is a Self-Directed IRA for Cryptocurrency a Good Idea?

Whether cryptocurrency investments in a self-directed IRA make sense for you can depend on your risk tolerance and investment goals. Cryptocurrency is a highly volatile asset, which means that while there’s the potential for higher returns you may also experience larger losses. So you may want to balance out the cryptocurrency investments in your self-directed IRA with other options, like real estate or precious metals in order to minimize risk.

Also, consider what you might pay in fees when trading crypto in a self-directed IRA. You may be charged a commission fee for each trade. There may also be annual account fees and/or one-time processing fees in order to set up a self-directed IRA for crypto or to create your account on a cryptocurrency exchange. The more you pay in fees, the more that can eat into your returns.

When comparing crypto IRA options, consider the minimum investment required as well. Some custodians may allow you to open a self-directed IRA for crypto trading with less than $100. Others might require a larger minimum deposit. So it’s important to note how much you might need to get started before opening an account.

Bottom Line

SmartAsset: Investing in Cryptocurrency With a Self-Directed IRA

Opening a self-directed IRA is something you might consider if you’d like to move beyond traditional investments for retirement. Whether you plan to open a self-directed IRA specifically for cryptocurrency or not, it’s important to understand the IRS rules that apply and the potential costs that might be involved. This can help you evaluate whether a self-directed retirement option is a good fit.

Investing Tips for Retirees

  • Consider talking to your financial advisor about whether setting up a self-directed IRA for cryptocurrency is something you should consider and how to do it. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • You don’t necessarily need to open a self-directed IRA for cryptocurrency trading. Many online brokerages allow you to trade different cryptocurrencies through a taxable account. And if you don’t want to own individual cryptocurrencies, you could also consider crypto mutual funds or exchange-traded funds (ETFs). While a taxable brokerage account doesn’t yield the same tax benefits as an IRA, it can be easier to set up than self-directed accounts. They may also cost you less in transaction fees each time you make a trade.

Photo credit: ©iStock.com/D-Keine, ©iStock.com/tdub303, ©iStock.com/Pekic

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