Bill Schmick: Cryptocurrencies and your retirement accounts

view original post

Investing in cryptocurrency has been legal in some retirement accounts since 2014. Few, if any, entities, however, have offered savers this option. That may be changing.

The IRS issued a Virtual Currency Guidance back in 2014. Since then, cryptocurrencies have been considered acceptable assets for self-directed Individual Retirement Account (SDIRA) and Solo 401(k) accounts. A self-directed IRA, which represents less than 3 percent of all IRAs, is a type of IRA that can hold a variety of alternative investments normally prohibited from regular IRAs. It can invest in things like precious metals, real estate, private placements, and cryptocurrencies. It is directly managed by the account holder, thus the term “self-directed.”

These SDIRAs are generally only available through firms that offer specialized custody services. There are additional fees involved as well due to additional compliance and IRA requirements. It is also your responsibility to abide by all the rules governing your investments, and if you fail to adhere to them, you could lose your SDIRA’s tax deferred status.

You face the same annual contribution limits as traditional, or Roth IRAs, and you can roll over funds from a normal IRA or 401(k) to a self-directed IRA.

If you are buying bitcoin or other cryptocurrencies in your SDIRA, keep in mind that doing so involves three components: A custodian holds your IRA and is responsible for its safekeeping, along with ensuring your accounts adheres to regulations set by both the IRS and government. This is the typical role financial institutions provide to holders of traditional IRAs.

An exchange, which is a different financial institution than regular stock exchanges, manages your cryptocurrency trades. In addition, a secure storage solution is necessary to protect your cryptocurrency purchases. This is necessary considering the number of hacking cases that have occurred in the cryptocurrency world. Many firms that offer SDIRAs also provide proprietary secure storage methods for bitcoin.

If you are self-employed, you can use a Solo 401(k) to buy cryptocurrency. The Solo is a unique retirement plan designed for self-employed individuals and small business owners. If you are eligible, you can establish a self-directed Solo 401(k) along the same lines as a self-directed IRA. You are bound to the same rules on contributions, and withdrawals that govern traditional 401(k)s.

As for those who would like to invest in cryptocurrencies in their traditional 401(k)s, Fidelity Investments announced last week that it will begin allowing investors to do just that. It is the first large-scale retirement plan provider to do so, but I expect it won’t be the last. Fidelity is the largest player with more than $2.4 trillion in plan assets for 23,000 companies.

That is good news, but there is a catch. While Fidelity may offer this opportunity, it is up to your company, as the plan sponsor, to agree to it. That could be a tall order, since most companies that offer 401(k)s take their role as a fiduciary very seriously. The fiduciary must ensure that the plan is being run in the best interests of the participants. Plan fiduciaries tend to be a conservative lot at best. Some could call them stodgy. Most are seen as a sober voice of reason. As such, it may be a stretch to believe that your company is going to simply okay buying bitcoin, or some other crypto offering, in your 401(k) anytime soon.

Fidelity recognizes this and has tried to reduce the risk somewhat by limiting crypto purchases to 20 percent of participant plan savings. It is an amount that plan sponsors can reduce further if they so choose.

The government may also provide a roadblock. The Department of Labor is not convinced cryptocurrency is a good idea in retirement plans. It is expected to open an investigation of plans that offer participants access to investments in cryptocurrencies. It is also planning to ask fiduciaries to demonstrate how they meet their required fiduciary duties of “prudence and loyalty” when choosing a cryptocurrency option for their plan participants. That challenge may be enough to deter many companies from considering cryptos in their investment menu.

I asked Berkshire Money Management’s Zack Marcotte, the best certified financial planner I know, what he thought of buying crypto currencies in retirement accounts. Here is what he said:

“Traditionally 401(k) providers avoid such aggressive holdings out of fear of being sued. Adding crypto to a 401(k) is appealing for younger more growth orientated investors. Investors considering crypto in their retirement accounts should know transactions carry high fees (and should avoid frequent trading) and limit how much crypto is owned to no more than a few percent of your total portfolio. Remember, the most successful investors aren’t those that know all the right investments, they’re the ones that avoid catastrophic errors.”

Sage advice. I think that it will take some time before the combination of government caution and fiduciary reserve can be overcome in most retirement plans. As for your own company plan, a trip to your human resources department to make your preferences known might be helpful, but don’t hold your breath.