Bitcoin IRA Investing:  5 Critical Questions To Ask Yourself First [October 2017]

by Bryan Ellis

Is the "Bitcoin IRA" a Real Thing? How Do You Set One Up? Is It Actually IRS-Approved? (NO!) And What Are The Big IRS Risks?

The Definitive Guide to Self-Directed IRA's

Bitcoin and other cryptocurrencies like Litecoin and Ethereum are booming in popularity, and frequently, in value.  The opportunity for savvy investors appears to be quite substantial.

But should you invest your IRA savings into Bitcoin or any other crypto-currency?  Is it even legal?

The legality question seems to lead to a clear answer of YES due to the power of self-directed IRA's.  I'll tell you exactly why this is true, but...

...there's a problem:  Some bitcoin companies are claiming that their investments are actually IRS-approved, and this is absolutely false, as you'll see.

We'll also explore the question of whether Bitcoin and other cryptocurrencies are appropriate assets for your IRA savings.

Bitcoin IRA InvestingBitcoin is booming.  It's wildly volatile, to be sure, but the general trend is amazing.  Take a look at this freshly updated chart of the value of Bitcoin in U.S. dollars:

 

 

 

This astounding growth has gotten a lot of attention lately, both positively and negatively.  Informal reports of investors receiving returns of 10X their capital and much more - in very short periods of time - have fueled massive growth in both public interest and actual capital allocation to Bitcoins.

But the news hasn't been all good, with such financial heavyweights as Jamie Dimon, CEO of financial behemoth Citigroup, stating flatly to CNBC:

 

 

Bitcoin sold off rather aggressively in the wake of this comment, but regained most of it's ground immediately thereafter, suggesting some strength even in the face of public criticism.

So Is bitcoin a legitimate currency, worthy of your investment capital?

Here's the truth:  I don't know.  You don't know either.  While I'm not at all certain that Jamie Dimon's analysis of Bitcoin's future is accurate, what I do agree with him about is the fact that bitcoin and other cryptocurencies represent a threat to governments in the one way that's most vital to them:  Control of currency...

...and governments don't tend to take kindly to having their monopolies threatened in the world of currency control.

On a fundamental level, that's my biggest concern.  So I leave to you the question of whether bitcoin is a smart investment for your IRA savings.

But I will comment on three other highly relevant questions:

  1. Is it possible to invest in Bitcoin, Litecoin, Ethereum, etc. using the money you've saved in your IRA or 401(k)?
  2. Assuming that it is possible to invest your retirement savings into cryptocurrencies, how can it be done?
  3. Are there any IRS-approved Bitcoin investments for your IRA?
  4. What Should You Know About The Extreme Risk Of Breaking The Rules In Your Bitcoin IRA?
  5. Is Bitcoin A Wise Investment for your IRA?

These are areas where I have substantive expertise to offer, so let's jump right in, shall we?

legal-advice-disclaimer

Is It Possible To Invest In Bitcoin Using Your IRA Funds?

Yes.  And No.  Here's what I mean:

The law doesn't prohibit you from investing your IRA savings into bitcoin, litecoin, ethereum, z-cash or any other cryptocurrencies.  So yes, it is theoretically possible to own cryptocurrencies in your IRA.

But that does not mean that your IRA is capable of making such investments.

You see, there are two types of IRA's:  captive IRA's and self-directed IRA's.

Captive IRA's are, far and away, the most common type of IRA.  These IRA's are usually offered through brokerage companies, insurance companies, banks and other conventional financial institutions.

I use the term "captive" IRA to describe these accounts because if you have an IRA at one of these institutions, your capital is held captive to the investment limitations they impose on you.

For example, you might be restricted only to the purchase of stocks or mutual funds or CD's.  But if you want to invest in other assets of a more alternative nature - including bitcoin - you're out of luck.

But there's another type of IRA that doesn't impose those restrictions.  It's called a Self-Directed IRA, and companies that offer self-directed IRA's don't impose any restrictions on their clients other than the (very minor) restrictions established by federal law.

This is great news if you'd like to invest in bitcoin, because the only explicit restrictions placed on IRA investments by the government are:

  • Life Insurance
  • Collectibles (like art, stamps, antiques, etc.)

Clearly, Bitcoin is neither life insurance nor collectibles.

That's great news!  This means that there isn't a stated prohibition of cryptocurrencies where your IRA is concerned!

In fact, the IRS issued a notice in 2014 that was very helpful for confirming how they view Bitcoin from a tax perspective.  The conclusion is very clear:  The IRS views Bitcoin as "personal property":

IRS Notice about Bitcoin - 2014

This clarification is really helpful if you want to invest in Bitcoin through your IRA.  That's because it confirms that Bitcoin is, for tax purposes, not a "coin" but "personal property".

Why does that matter?  It's simple:  Coins are usually considered to be "collectibles" by the IRS... and collectibles are one of the 2 categories of assets wholly prohibited for investment in IRA's...

...But being categorized as personal property, the IRS essentially gave a green light to Bitcoin (and other so-called virtual currencies like Litecoin, Ethereum, etc.) as an asset that is compatible with IRA's.

And yet, the fact that it seems clear that it's legal for you to invest IRA money into Bitcoins, the fact remains:

Most IRA's are captive IRA's, and will not allow you to invest your IRA savings into cryptocurrencies.  If that's what you've discovered when contacting your IRA provider, the solution is simple and leads nicely into our next big question...

If It Is Possible To Invest Your IRA Into Bitcoin, How Can It Be Done?

 

 

Let's start from ground zero on this question.

There are X steps to investing your IRA savings into Bitcoin or other cryptocurrencies.

Step 1:  Open a Bitcoin-Compatible IRA

Most IRA companies can not accommodate investments in Bitcoin.  But there are a precious few who can do so.

You must use an IRA provider who offers what's known as a truly self-directed IRA rather than the more common variety known as Captive IRA's.

Establishing such an IRA is very simple.  Just select a self-directed IRA provider (a free list of all self-directed IRA providers is available here) and open an account with them.

Easy enough!

Step 2:  Deposit or Transfer Capital To Your New IRA For Bitcoin Investing

If you have saved money in another IRA, you can transfer that money into your new self-directed IRA.

Alternatively, you could simply make deposits directly into your new self-directed IRA.  Presently, the annual contribution limit is between $5,500 and $6,500 depending on your age, but you should definitely speak with a tax adviser to get the specifics.

Step 3:  Establish a Bitcoin Wallet For Use In Your IRA

A "wallet" is the Bitcoin equivalent of a bank account.  Your wallet is where you store your bitcoins, and where you are able to conduct transactions with them.

Your IRA will need it's own unique wallet.  If you already have a Bitcoin wallet that you use for other purposes, you'll still need a new Bitcoin wallet for your IRA, because it is totally prohibited for you to mix your own personal financial details with anything done in your IRA.  This is a serious rule you must not break.

So what you should do next is contact your self-directed IRA custodian, and ask how to establish a Bitcoin wallet for use in your IRA.  Your IRA provider may have specific vendors or protocols that they prefer to use in order to maintain the safety and security of your Bitcoin wallet.

A few self-directed IRA custodians are still leery of allowing you to establish a Bitcoin wallet directly in your IRA.  The reason they offer is that Bitcoin offers strong privacy protection, and that the connection between Bitcoin wallets and the owners of those wallets is hard to confirm publicly.  And since your self-directed IRA provider could be held responsible if anything bad happened to your IRA due to negligence, some of them are a little nervous about this.

Even in that case, there's a relatively simple solution.

In that case, just ask your self-directed IRA custodian how to set up a "Checkbook IRA LLC".  They'll know what this is, but in short:

A checkbook IRA LLC allows you to directly handle the capital you put in your IRA without your self-directed IRA custodian being directly involved.  It's basically a way that allows them to give you more flexibility in managing your money without them having to take on a huge amount of legal risk.

In other words, it's a win-win for you and them.

So now, you have a Bitcoin Wallet established in a self-directed IRA.  It's time to buy and sell based on your own analysis of the Bitcoin market.  Just be careful!  The volatility of this asset is a bit scary sometimes.

Are There Any IRS-Approved Bitcoin Investments For Your IRA?

The news here isn't good.

Several companies actually claim that their Bitcoin investments are IRS-approved.

Nothing could be further from the truth.

Remember this:

The IRS does not approve IRA investments.  Period.  Ever.

The IRS doesn't approve investments.  Rather, they provide a list of the types of assets that are prohibited.

You've already seen that that list is pretty short.  It includes only life insurance and collectibles.

But does that mean that anything that isn't prohibited is therefore approved by the IRS?

Absolutely not.  That's why they issued the notice above.

Here's another way to look at it:

The IRS gives us a list of the things that they consider to be included in the definition of "collectibles", one of the prohibited asset classes.  That list is here:

All of these are pretty clear concepts, but look at that last item:  "Certain other tangible personal property."

That's nearly as vague as it can be, and it's that way on purpose.  What it means, in essence, is that the IRS can decide at any time that they think a particular asset is a collectible, and is therefore prohibited in your IRA.

That's why you can never, ever assume that any investment is approved by the IRS for investment in your IRA.  The IRS has never given such an approval, and I suspect they never will.

Important Note:  That IRS notice goes so far as to suggest that anybody claiming that their investments are IRS-approved are "fraudulent" investments:

I don't know if it's a reasonable assumption that anyone claiming to be IRS-approved is inherently fraudulent, but it would certainly give me pause to see such a claim, if only as an indication that such a person or company does not have competent tax lawyers on staff.

I believe it's particularly critical for you to understand that there aren't any Bitcoin investments that are approved by the IRS.  I think this is important because, while I wish it wasn't true, I suspect that Bitcoin or other cryptocurrencies could ultimately become the target of the government once they get past the "novelty" phase and begin to actually represent major assets in the financial world.  Like I said, the government isn't a fan of being threatened in it's monopoly on currency creation.

What Should You Know About The Extreme Risk Of Breaking The Rules In Your Bitcoin IRA?

 

I think that Bitcoin is actually extremely well suited, in terms of structure, for being an IRA investment.

(Again, I'm not making a recommendation for or against it in terms of profit potential or suitability.  But in terms of structure, it's a good fit for IRA's.)

The reason I say this is because, like stocks, basically all you can do with it is to buy it, hold it and sell it.  And the good news is:  All of those things are basically compatible with the rules for IRA's.

But there are some things you need to know about investing in alternative assets in your IRA.

First, it's a very serious issue.  So serious, in fact, that the U.S. Government Accountability Office did an entire study - a very big study - about this.  Their conclusion was that investors - that's you - need a lot more guidance to avoid problems.

Here's what that notice from the IRS looks like:

This is a big deal because if you break the rules in a self-directed IRA, you're probably guilty of committing what's known as a prohibited transaction...

...And let's be clear:  Committing a prohibited transaction in your IRA is usually financially cataclysmic.  It's common to lose half of your IRA because of these errors.  It's entirely possible to lose the entire thing.

You must avoid this type of error at all costs.

Fortunately, most of the types of errors that apply to other alternative assets won't apply to Bitcoins.  But some of the potentially big problem areas include:

  • Never, ever use your IRA's bitcoin wallet to buy from, pay to or otherwise conduct transactions with anyone related to you.  (The IRS calls them "disqualified persons".)
  • Similarly, don't use your IRA's bitcoin wallet to conduct transactions with any businesses you own or control.  Those are also considered to be disqualified persons.
  • Neither you, nor any disqualified persons, should ever be able to use the assets purchased by your IRA, or by your IRA's Bitcoin wallet.  That's a clear prohibited transaction.

A good rule of thumb is to always take a moment to talk with a well-qualified self-directed IRA attorney before setting up your Bitcoin IRA, and before executing any transactions that are in any way unusual.

Safety first!  The pain of make an error will be overwhelming, so don't let it happen to you.

Is Bitcoin A Wise Investment For Your IRA?

Bitcoin may have a place in your IRA portfolio... but it should be the same place that might be held by any other highly speculative asset.

To be certain, there appears to be substantial profit potential.

But profit potential alone doesn't make for a wise IRA investment.  From what I've heard, drug dealers make a lot of money, but that's no reason to guide your retirement investments in that direction!

I'm not trying to equate Bitcoin with illicit activities.  Not at all.  Nor am I throwing shade at Bitcoin just because it's highly volatile and speculative.

Investments of that type can have a place in your IRA.  But from my point of view, the proportion should be small... maybe even tiny.

Here are some of the fundamental reasons that Bitcoin concerns me as an IRA investment:

  1. The history of this asset is incredibly small.  We have no idea how it performs under pressure.
  2. China has already placed severe restrictions on virtual currency offerings and trade.
  3. As Bitcoin becomes more and more viable as a "currency", other governments - including the United States - will see it as a threat and take action.  Don't underestimate the power of the federal government to crush this movement if they choose to do so.
  4. The relatively high privacy potential of Bitcoin transactions makes it difficult to imagine that it isn't being used in illicit transactions of some sort.  This issue alone will provide all the opening needed by governments to take extreme action against virtual currencies.
  5. The SEC is presently pursuing prosecution of two "Initial Coin Offerings" that appear to be fraudulent.  While Bitcoin does not appear to be fraudulent, the value of Bitcoin is likely to suffer due to "guilt by association" as news of more and more such prosecutions is released to the public.

I think all of these are legitimate considerations.  But again, I do not suggest that Bitcoin should be written off as an IRA investment...

...I say on that you should exercise extreme, extreme care.

After all, we self-directed investors are obligated to do one thing:  Respect our own capital!

 

 

Bitcoin IRA Investing:  5 Critical Questions To Ask Yourself Is A Work In Progress.  Check Back For More... We've Not Even Scratched The Surface Yet!

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About The Author


Bryan Ellis

I am host of Self Directed Investor Talk, which I'm told is America's #1 podcast and for affluent self-directed investors. I'm also something of an expert in self-directed IRA's, solo 401k's and 1031 exchanges. You can find more of my writing in some cool places like TheStreet.com, Entrepreneur.com, ThinkRealty and even Forbes (that was always one of my goals!). I live in metro Atlanta, Georgia with my wife and business partner Carole Ellis(she's a real business partner... not just because she's my wife... I'd want to work with her if I wasn't married to her... and I'd want to marry her, too). I also have 4 children ranging in age from 2 to 20 (yes, you read that correctly). It's my goal to be the name everybody thinks of when they think of Self-Directed IRA's and Solo 401(k)'s.