What is a Bitcoin IRA? A Guide to Cryptocurrency IRAs
By: Ofir Beigel | Last updated: 1/25/23
Note: The following post is relevant for US citizens only and is meant for information purposes only. It is not intended to offer any investment advice. Any action regarding your financial future and IRAs should be done in consultation with a financial advisor or tax professional.
Bitcoin and cryptocurrency IRAs, in general, are an extremely powerful investment tool that lets you save a lot of taxes from your cryptocurrency trading and investment operations. Here’s everything you need to know about them.
What is a Bitcoin IRA Summary
A Bitcoin IRA is a tax-free investment account that allows you to invest money in order to trade in Bitcoin or other cryptocurrencies. The account is aimed at building wealth toward your retirement and the money in it cannot be withdrawn before retirement age without incurring a penalty. There are two main types of Bitcoin IRAs – a traditional IRA and a Roth IRA.
That’s what a Bitcoin IRA is in a nutshell. If you want a more detailed review keep on reading. Here’s what I’ll cover:
- What is an IRA?
- The 2 Types of IRAs
- Bitcoin and Cryptocurrency IRAs
- IRA Limitations
- The 3 Ways to Start an IRA
- Choosing an IRA company
Don’t Like to Read? Watch our Video Guide Instead
IRA stands for “Individual Retirement Account”. It’s an investment concept that started in the 1970’s to incentivize Americans to save more for retirement. In simple words, it’s an investment portfolio with great benefits, but in order to get those benefits you have to wait until you retire before you cash it out.
What benefits? SIGNIFICANT tax benefits such as tax-free trading, tax-deferred gains or tax-free gains. IRAs have been extremely successful with several enhancements over the years. Today, investors hold over $9 Trillion dollars worth of investments in IRAs.
There are two different types of IRAs.
Traditional IRAs were introduced with the Employee Retirement Income Security Act of 1974 (ERISA) and made popular with the Economic Recovery Tax Act of 1981.
The traditional IRA gives you a tax write off each time you invest money in it, commonly known as making an “IRA Contribution”. Additionally, you can make an unlimited amount of trades in this account without them being considered taxable events by the IRS.
With traditional IRAs, the income you deposit is not subject to income tax: well…not yet. Instead, you pay taxes only on the amounts you withdraw after you’ve retired. However, if you decide to cash out your money from a traditional IRA before your specific retirement age, usually 59 and a half, you will get penalized by paying all of the income taxes you deferred on the deposits and on any gains realized, as well as an early withdrawal penalty.
The “Roth IRA” was introduced as part of the Taxpayer Relief Act of 1997 by Delaware Senator William Roth.
The Roth IRA requires IRA contributions to be made only from earned income which has already been taxed. Like a Traditional IRA, You can make unlimited trades in the account without any tax implications.
With a Roth IRA all the gains and withdrawals you make during your retirement are tax-free since you already paid taxes on your deposits.
Roth IRA’s are one of the most powerful investment vehicles in the world, but it’s important to know that unlike a traditional IRA, not all investors can open one. Generally speaking, the Roth IRA is not available for people who make over a certain amount of income per year.
For example, in 2020 you won’t be able to contribute to a Roth IRA if you have an income greater than $139k dollars for a single or $206k dollars for married couples filing jointly. However, those limits don’t apply to opening and contributing to a traditional IRA.
To sum it up the difference between a Traditional IRA and Roth IRA comes down to “Do you want to pay taxes now, or do you want to pay taxes later?” This is something for you, your financial advisor and/or your tax professional to decide.
Until recently, IRA’s were primarily used to trade and invest in Stocks and Bonds but now investors are able to buy and sell Cryptocurrencies in their IRA’s as well. This has birthed an entirely new industry, which frequently falls under the category of “Bitcoin IRAs” or more generally – “Crypto IRAs”.
Crypto IRAs are companies that allow you to open an IRA and buy/sell cryptocurrencies on their platform without having to worry about paying taxes on each trade.
For example, normally if you buy Bitcoin at $5,000 and sell it at $10,000 – you’d make $5,000 of
capital gains, on which you would be required to pay taxes. In a Crypto IRA, however, you wouldn’t owe any money on taxes, since tax-free trading is a unique benefit of Individual Retirement Accounts.
While IRA’s can provide huge benefits for investors, there are still a few things to consider.
In order to build your IRA, you will need to contribute money each year that will count as your IRA contribution. Since IRA contributions are capped at certain amounts per year, you can’t just put all of your money into an IRA and receive the benefits.
For example, in 2020, the IRA contribution cap is $6,000, or $7,000 if you are over the age of 50. This typically increases each year, so you will want to do some research on how much you can contribute.
With Traditional IRA’s, while investors have the ability to trade between various assets, they can only withdraw money out of their IRA and into their own personal bank by performing a process known as a “Distribution”.
Distributions are normally reserved for people who have reached their retirement age, which, for most people, is defined in these tax laws as 59 and a half.
While there are some exceptions, including filing for early retirement, normally if one wants to
take a distribution before retirement age there will be an early distribution penalty. It’s important to talk with your tax or financial advisor to learn more about how distributions work.
For Roth IRAs, the principal can be withdrawn at any time with no penalties. This means that if you Invested a total of $6,000, and it turns into $12,000, you can still withdraw up to the invested principal amount of $6,000 at any time.
In addition to withdrawing the principle at any time, investors can withdraw some profits from their Roth IRA under certain qualifying circumstances. These include a first-time home purchase, medical expenses, higher education, and disability among others. As I’ve mentioned before, it’s important to talk with your tax or financial advisor to learn more about such qualifying circumstances.
Starting an IRA from Scratch
You can start a crypto IRA from scratch. This means you’ll open a new IRA account and start making contributions to it.
401K Roll Over
You can fund your crypto IRA with what is known as a “401k Roll Over”. This is where an investor takes a 401k or other retirement account from an old employer and rolls it over into an IRA. This does not trigger a taxable event but simply gives you more flexibility, as IRA’s are more flexible than 401k’s.
You can fund your crypto IRA with what is known as an “IRA Transfer”. This is where an
investor takes an Existing IRA from another financial institution and transfers it to their
new IRA, which allows Crypto investments. This transaction does not trigger a taxable event but
simply allows the investor to pair with a new financial institution, one that likely allows
investments that the investor wishes to access such as cryptocurrency.
Cryptocurrency IRAs require several factors to come together – for example, you need a trustee to hold your funds and to allow you to deposit contributions. You’ll need a trading platform to manage how you invest and trade. You’ll also need a custodian for your cryptocurrencies and access to a cryptocurrency exchange for conducting trades.
There are several companies, like iTrust Capital or Bitcoin IRA out there that act as facilitators and merge all of the elements I just talked about together. It’s important that you do your own research and find one that fits your investment goals.
Here are a few important things to consider when choosing a company to manage your IRA:
Initially, fees are one of the most important things to consider when choosing a Cryptocurrency IRA provider. Be sure to investigate all of the fees and get them in writing. Here are the most common fees you’ll find:
- Initial Purchase Fees – May be charged upon your first purchase of the crypto assets.
- Trading Fees – May be charged each time you perform a trade or transaction.
- On-Going Fees – Include account setup, storage, administration, platform fees and much more.
If you’re looking into a Bitcoin IRA you’ll also want to research how the invested cryptocurrencies are stored and secured. Important questions to ask are:
- Where are the coins held?
- What security measures are taken to keep them safe?
- Who is the custodian for the coins and what is their reputation?
Custodians will usually have a whitepaper to help potential investors understand the security available, so make sure to read that as well.
Finally, you’ll want to take a look at the trading platform that allows you to manage your IRA funds. The way trading is conducted is incredibly important, you will want to test out the platforms and find one that is easy to understand and use. Here are a few questions to answer:
- Is there a 24/7 trading platform, or am I required to call in for every single trade?
- Can I test out the trading platform before signing up?
- What cryptocurrencies are available for trading or investing?
- Can I withdraw distributions in cryptocurrencies as well as in dollars?
Hopefully, by now you understand what a Bitcoin IRA is – A retirement oriented investment account that allows you to invest in cryptocurrencies with substantial tax incentives. If you’re serious about cryptocurrency and Bitcoin investments for the long term it may be worth your time to use an IRA in your personal portfolio.
Do you currently have a Bitcoin IRA? Do you have any additional questions? If so, let me know about them in the comment section below.