With a practice focused on cryptocurrency and estate planning, I’m often called upon to help my clients with their IRAs, Roth IRAs, 401(k)s, and other retirement accounts.
As I’ll explain in this post, most “Bitcoin IRAs” aren’t cutting it. There is a better option for holding Bitcoin in an IRA.
As I write this, yields in many traditional retirement investments are at all time lows. This has sent investors scrambling to find creative ways to invest.
Bitcoin, being limited in supply, has appreciated in value against fiat currencies. Although nothing is guaranteed, many believe these trends will continue, especially with governmental and economic uncertainty throughout the world. You may therefore wish to move some retirement funds into Bitcoin or another cryptocurrency. For a variety of legal reasons, however, this can be tricky.
While I refer to “Bitcoin” in this article, the same steps are true for Ethereum or any other cryptocurrency.
And a quick note: all references to an “IRA” in this article refer not just to traditional IRAs, but also to Roth IRAs. The strategies in this article are also available for 401(k)s, as discussed later.
When you hold funds in an IRA (or Roth IRA), under the Internal Revenue Code, the default rule is that the funds may not be held by you directly. They must instead be held by a custodian for your benefit. The custodian is typically your bank or brokerage. The first issue when holding Bitcoin in a retirement account, then, is that most custodians will not allow Bitcoin to be held in their accounts. Further, even if a custodian would allow such a setup, it would mean having a third party in control of the private keys, which is sub-optimal from a security standpoint.
Even if you were comfortable with a third party holding Bitcoin on your behalf, some IRA custodians that do allow Bitcoin holdings require that your IRA invest in the Grayscale Bitcoin Investment Trust (“GBTC”) rather than actual Bitcoin. GBTC is basically a big fund full of Bitcoin. With GBTC, your IRA doesn’t actually hold Bitcoin; it holds an interest in a fund which promises to hold Bitcoin.
This may be unsatisfactory for a variety of reasons. First, the GBTC requires all investors to be “accredited”, which, slightly oversimplifying, meanings they must have either more than $1M in net worth or greater than $200,000 per year in income ($300,000 combined for a married couple). This standard necessarily omits many younger investors. Further, investing in GBTC requires placing trust in the fund itself. Many would rather have the peace of mind that comes with holding their own Bitcoin. Lastly, GBTC charges fees which eat away at returns.
There are a few special “Bitcoin IRA” companies out there that don’t require using GBTC, however they do still hold your keys and charge crazy custodial fees for doing so.
Wouldn’t it be great to avoid all these issues by just holding cryptocurrency directly, in control of your own private keys, while still maintaining the tax benefits of an IRA? It turns out there is a way to do this, so long as you know how to avoid the hidden traps.
Step 1: A Checkbook IRA
The first step is to form a “checkbook LLC” for your IRA. With a checkbook LLC IRA, your IRA invests in a single member LLC, of which your IRA is sole owner. You personally are appointed manager of that LLC. As manager, you have free reign to invest the LLC’s funds as you wish, without custodian approval.
While checkbook IRA LLCs are allowed under IRS rules, they don’t obviate the “prohibited transaction rules” of IRC 4975. IRC 4975 outright bans IRAs (including LLCs owned by IRAs) from investing in certain classes of assets. The good news is that Bitcoin is not one of those classes. In fact, the IRS considers Bitcoin to be property rather than currency, making it an investment similar to real estate, stocks, or bonds for tax purposes.
(Note: We can set up a checkbook IRA-LLC for you. Click here to get started.)
Even after you have your checkbook IRA LLC set up, the prohibited transaction rules present unique obstacles to holding Bitcoin directly, as described below.
Step 2: Loading the IRA LLC
The first obstacle is purchasing Bitcoin at a reasonable exchange rate in the name of the LLC, rather than in your personal name. It’s very important to note that a transfer of cryptocurrency from you to your IRA (or IRA LLC) is a prohibited transaction. This is because cryptocurrency is considered property for tax purposes, and IRA contributions must be made in US Dollars. So it is key to first transfer US Dollars into the IRA, which will then flow into the LLC’s checking account. From the LLC’s checking account, Bitcoin can be purchased.
To do this, you will need to open an account on a cryptocurrency exchange. Unfortunately, many cryptocurrency exchanges do not allow accounts in the name of an LLC. Examples of exchanges which do allow LLC “institutional” accounts are Gemini, ItBit, Kraken and Coinbase Pro. Customer service may tell you that it’s easier to simply set up your exchange account in your own name and attach your LLC bank account, but again, to be extra safe regarding the prohibited transaction rules, I don’t suggest this. Be sure to open a full “institutional” account in the name of your LLC.
I would also suggest sticking to US-based exchanges, as using a foreign exchange would create a requirement of FBAR reporting.
If you are able to use a decentralized exchange, that would be another option. Unlike Gemini, ItBit, or Coinbase Pro, decentralized exchanges do not register an “account” in anyone’s name, so they eliminate the obstacle of getting an account titled to an LLC. Decentralized exchanges are very new, however, and aren’t yet accessible to most people. For this reason, most will stick to the traditional cryptocurrency exchanges above.
Step 3: Getting an IRA LLC Wallet
Your next obstacle is deciding on a wallet for holding your cryptocurrency. If your cryptocurrency holdings are small, you may choose to leave them in your exchange trading account. But if they’re larger, you may wish to transfer them to an external wallet for security. It is VERY important that “ownership” of the wallet must vest in the LLC, not you personally. This is because any exchange of assets between you and your IRA (or your IRA LLC) is a “prohibited transaction” under IRC 4975(c)(1).
The cleanest solution to ensuring a wallet “owned” by the LLC is to use a cold storage method. In addition to being easily “owned” by the LLC, Bitcoin in cold storage is very secure. One option for cold storage would be to use a hardware wallet such as a Trezor.
Alternatively, you could decide to store your LLC’s cryptocurrency in paper wallet format. Coindesk has some great info on what a paper wallet is and how to create one here.
A quick note about 401(k)s: In this article, I discuss holding Bitcoin in an IRA. However, if you have a self-directed 401(k) (a type of plan typically only available to a self-employed business owner), the process works much the same. In fact, it is slightly easier. Unlike IRAs, self-directed 401(k)s do not require a third party custodian. A 401(k) does have a trustee, but typically the business owner will be trustee of his own plan. This means that as trustee, you can invest 401(k) funds in Bitcoin using the steps above directly, rather than having to set up an LLC intermediary. If you need help setting up a self-directed 401(k) for your business, contact us.
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Disclaimer: Information provided is for educational purposes only. Nothing herein constitutes legal advice or investment advice. Readers are responsible for their own due diligence in selection of investments, exchanges, and technology platforms.