When I recently published an article on my website about Bitcoin IRA investing, a firestorm ignited among my readers and listeners of the Self-Directed Investor Talk podcast. When the dust settled, the most common question I’d received, by far, was this:
“How can I invest in Bitcoin in my IRA?”
The good news is that it is possible to buy Bitcoins in your IRA, and there are several ways to do it. The bad news is that it’s easy to be taken advantage of if you aren’t familiar with the alternative asset capabilities of IRAs and 401(k)s.
Does the IRS really allow the purchase of Bitcoin in IRAs?
Contrary to popular opinion, IRAs are not limited to stocks, mutual funds and other Wall Street-centric asset classes. In fact, the only asset classes explicitly prohibited by law for purchase in an IRA are life insurance and collectibles.
Bitcoin is neither of those. As such, it’s broadly accepted that Bitcoin is not prohibited from purchase in an IRA.
But, the lack of an IRS prohibition and an explicit IRS endorsement of Bitcoin are not the same. Because of that, some of the newer “Bitcoin IRA” types of companies use deceptive marketing that directly states or strongly implies that the IRS has approved the investments they offer. But these claims are entirely false and fraudulent, according to the IRS.
So, if Bitcoin is not prohibited for purchase in your IRA, how’s it done? Follow these three simple steps:
Step 1: Use the right kind of IRA.
Yes, Bitcoin is compatible with your IRA. But, when you call your IRA provider to invest in Bitcoin, you’re quite likely to discover that they simply will not facilitate a purchase of Bitcoin with your IRA funds, even though the law doesn’t prohibit it.
Why is this?
Most IRAs fall under the category of captive accounts, which limit your investment options to the assets directly offered by the IRA company. So, if your IRA company doesn’t directly offer bitcoin to you, you’re out of luck.
That is, you're out of luck unless you use a self-directed IRA instead. A self-directed IRA is identical to a captive IRA in every way except one: Where captive IRAs limit your investments to those assets sold by the IRA company itself, self-directed IRAs empower you to invest in any asset the law allows, including Bitcoin.
The real distinction between captive IRAs and self-directed IRAs is in the IRA provider itself. So, step one of investing in bitcoin through your IRA is to transfer capital from your current retirement account into an account at one of the many excellent self-directed IRA custodians.
Step 2: Establish a Bitcoin wallet.
Having transferred capital into a self-directed IRA, you must now set up a “wallet” for use by your new IRA. A wallet is the cryptocurrency equivalent of a safe deposit box that holds the information necessary to buy, sell and use your Bitcoins. Wallets are provided by many vendors and offer varying degrees of security.
Before you establish a wallet for your IRA, contact your self-directed IRA custodian to determine their preferred strategy. Some custodians will allow you to establish a wallet directly in the name of your IRA. Others will require you to take the intermediary step of establishing a limited liability company (LLC) within your IRA to hold your Bitcoin wallet.
The direct style is certainly simpler, and I suspect it will become the standard in the near future. As for now, it’s usually cost-prohibitive. There are a few Bitcoin-oriented IRA providers that allow direct ownership by your IRA, but most of them are outrageously expensive, frequently charging exorbitant commissions of up to 15% or more of your IRA balance.
If you find a reasonably priced IRA provider that allows for direct wallet ownership by your IRA, go for it. Otherwise, the great news is that the alternative of creating an LLC within your IRA to hold your Bitcoin wallet is both simple and inexpensive. You should expect to be charged a few hundred dollars each year to maintain proper government registration of the LLC. If you use this LLC exclusively for Bitcoin trading, the LLC strategy is a simple, elegant and inexpensive solution.
Step 3: Fund your Bitcoin wallet with IRA funds only.
The final step before actually investing your capital into Bitcoin is to fund your Bitcoin wallet using capital from your IRA -- and only from your IRA. You cannot comingle your IRA funds or its wallet with capital from any other source. Such comingling is unambiguously prohibited by the IRS and will cause you tax problems of a cataclysmic nature.
To prevent such problems, always think of this term: exclusive benefit. In other words, your IRA’s Bitcoin wallet (whether owned directly or through an LLC) must be for the exclusive benefit of your IRA. Similarly, all investment capital placed in your IRA’s Bitcoin wallet -- including fees paid to establish a wallet and/or LLC -- must come directly from the funds in your IRA.
The IRS offers zero flexibility on this requirement. It’s not even acceptable to use personal funds and then reimburse yourself from your IRA. All of the capital involved in establishing or funding your bitcoin wallet must come directly from and return directly to your IRA (or LLC) with no detours in between.
That’s it. By following these three simple steps, you’ll have configured your IRA to invest in Bitcoin and other cryptocurrencies. But there is, of course, an additional step you should take before executing your first bitcoin transaction: Consult with an objective, qualified, third-party adviser to confirm whether Bitcoin is right for your IRA and, if so, in what quantities.
After all, Bitcoin could change the world and make you rich, or it could result in 100% loss of your capital. Invest accordingly.
