401(k), Roth 401(k), and Traditional Individual Retirement Account IRAs are seen as ‘no-brainers’ when it comes to finding unused capital to stack bitcoin for your retirement. But nobody is talking about the long-term implications that pose enormous risks to those seeking to use their IRA to finance a bitcoin purchase.
What is an IRA?
Standing for “individual Retirement Account”, an IRA is a retirement account that anyone can open with a broker that allows you to contribute pre-taxed or after-tax income into a retirement vehicle depending on income limits. Many use this investment account to lower their taxable income prior to the tax deadline to avoid paying a high tax bill. A Traditional IRA is an example. However, some will utilize what’s called a Roth IRA that will allow an individual to contribute after-tax money today and withdrawals are tax-free once the age of retirement is reached.
With the introduction of bitcoin as a potential asset that can be placed in an IRA, investors should take note and weight the pros and cons of this tax-advantaged structure.
Think twice, before you put bitcoin in your IRA.
Fidelity recently announced that employees can add bitcoin to their 401(k) later this year and this has been met with mostly enthusiasm. Anthony Scarmucci, a once bitcoin skeptic but now converted apologist, tweets “….Fidelity’s engine of distribution will swell demand.” Anyone within the bitcoin space can envision this as positive news for growth and a major signal for increased adoption for those outside of traditional crypto spaces. While the size and scope of Fidelity is hard to ignore, it is not the first time the option of placing bitcoin in a retirement vehicle has become available. Choice via Kingdom Trust and iTrust capital are good options to name a few.
Putting bitcoin in your IRA – What’s the catch?
So what can be wrong with a bitcoin option in my IRA you might ask? Well, this is a tricky question and does require some projections into the future but contributing bitcoin to your IRA could come a cost. With most retirement products, you are discouraged from accessing the funds until retirement. This makes sense, after all, it’s in the name. You can be accessed an early withdrawal penalty as well as pay capital gains tax on any earnings, depending on your circumstance. Effectively, funds and assets are locked into your IRA account until you reach retirement age and there is little you can do to get a hold of these funds without paying for them if you elect an early withdrawal.
“You must sell your bitcoin in order to use the funds. Yes, this is correct. You must sell your bitcoin to use your money.”
But herein lies the conundrum, if you purchase bitcoin in an IRA and hold it until your retirement, congratulations, you can now withdraw the funds, tax-free if using a Roth IRA, to use as you see fit. However, you must sell your bitcoin in order to use the funds. Yes, this is correct. You must sell your bitcoin to use your money. You are probably asking yourself the same question as me, why would I hold bitcoin for 10, 20, 30 plus years, and then when I’ve earned the right to use it, sell it? I have a hard time wrapping my head around this notion too. This is no different if you hold any other asset in your IRA, stocks, bonds, commodities, etc. You can’t go to Wal-Mart, Amazon, or any other retail location and buy groceries with stock, can you? Maybe in the future, but not today. The bottom line is you have to sell assets in your IRA to use the funds. Bitcoin is the same. Hopefully, in the future, an option to withdraw bitcoin from your IRA without selling will be an option, but currently, this isn’t available.
Not your keys, not your coin
I offer a better approach to investing in bitcoin without placing in a tax-deferred IRA, you have access to the funds at any time without selling, and can hold them forever.
Borrow against your bitcoin.
You never have to sell it to utilize the equity and you still have ownership over it whilst capturing the upside. Many companies offer loans against bitcoin with variable APR ranging from 8-12% currently with Nexo or Coinbase. These fees are quite high and would deter many from using this approach and rightfully so. But in the future, competition for your business will heat up and interest rates on loans will be much lower.
There are risks associated with taking out a loan against your bitcoin and they should be strongly considered prior to any investment decision. You have to deposit your bitcoin with the exchange/custodian in order to receive the fiat, stable coin, or another asset of your choice. This poses counterparty risk and trust that the custodian or holder secures your asset appropriately.
An even bigger risk is commingling and rehypothecation. This occurs when your bitcoin is used as collateral for other loans by the lender, and then is used as collateral to cover other exposures. A single exchange hack or default could bring down the entire structure with, ultimately, you losing your bitcoin.
Additionally, most loans originate on a Loan to value (LTV) percentage and your collateral must remain at the specified amount compared to the borrowed balance or risk a margin call. For example, if you want to borrow $5000 at an LTV of 15%, you must deposit north of $33,000 in bitcoin. If the price of bitcoin drops rapidly, you risk a margin call to deposit more collateral or risk loss of your collateral. As highly volatile as bitcoin, this is very risky from an investment standpoint. Deferring any loan until the price is smoother could be safer and more worthwhile. Consult a financial advisor and know what you are getting yourself into first.