Have the recent price fluctuations in the cryptocurrency market caused you to take notice? If so, you might have decided to put some of this alternative currency into an IRA but aren’t sure how. Don’t feel bad. Millions of working adults have the same kind of question, namely, “What’s the best way to create a self-directed IRA and place cryptocurrency into it?”
For those who are serious about getting started, there are a couple of preliminary steps. First, you need to understand the basics of how self-directed IRAs work. Then, it’s essential to know how to create an IRA that can hold crypto.
Finally, do enough research to feel comfortable about the positive and negative aspects of putting crypto into a SDIRA (self-directed IRA). You need to do these preliminary steps because cryptocurrency is a very new kind of asset compared to things like stocks and bonds.
What does the IRS say about cryptocurrency? Well, the government tax agency considers crypto to be property, not money. That is extremely important because property is taxed differently from cash or other kinds of cash-like assets.
Before delving into the nuts and bolts of how to set up a crypto-based SDIRA, let’s first look at the recent history of price movements in the cryptocurrency market.
Price History of Cryptocurrency
There are no intermediaries between holders of cryptocurrency. That’s because the entire network it’s built upon, a decentralized exchange is 100 percent digital, is not “physical” in any sense of the word, and is not under the control of any of the world’s governments or corporations.
Since 2009, when the first crypto arrived on the scene, thousands more have followed. Of all the successful ones, prices have generally risen by a substantial amount since then.
Once prices of the top three cryptos took off after 2015, millions of investors worldwide began to pay attention to what was, at first, considered an experimental form of money that might fail. There were lots of “crypto millionaires” during the middle of the last decade, which is the main thing that popularized the potential of cryptocurrency and caused most everyone to realize that, as an asset class, it was here to stay.
By the end of 2018, the leading alt-coins (another name for cryptocurrency) had settled down to a common price level, even though they were all about double or triple their values of the year before. Slowly, between early 2019 and early 2020, prices for most of the leading coins either held stable or rose considerably.
When the COVID-19 virus caused significant turmoil in the global economy, so many investors viewed cryptocurrency as a hedge against an economic catastrophe that prices rose again, but this time by a lot. After the middle of 2021 passed, and the pandemic hung around for the long run, crypto prices sank back down, but not as much as they had risen.
What does the rest of the decade hold, price-wise, for the alt-coin market? There’s no precise way to predict the future, but it’s worth noting that nearly every time cryptocurrency prices have risen, they tend to fall back to a higher holding point than the previous low. In other words, the overall price of alt-coins tends to be edging up, if history is any guide.
How Do Crypto SDIRAs Work?
In many important ways, SDIRAs that hold cryptocurrency are similar to the kinds of IRAs most people are already familiar with, the so-called “traditional” and Roth versions. All IRAs can be funded with either after-tax income or pre-tax income. But, the primary way a crypto self directed ira differs is in what kinds of assets they hold, namely cryptocurrency.
If you go to your bank or broker and open a traditional or Roth IRA, you can usually only fund them with stocks, an approved list of mutual funds, or cash. That’s about it. The financial institution will tell you what kinds of assets you can put in, and the list is a short one for regular IRAs.
Self-directed IRAs are very different in this regard. For example, you can put a wide variety of assets into SDIRAs, including physical assets like precious metals, alternative forms of money like cryptocurrency, stock options, stocks, bonds, futures, commodities contracts, real estate, and much more. Of course, by law, you can never put collectible assets or life insurance policies into any IRA, ever.
Once you decide to create a cryptocurrency self directed IRA and put crypto into it, step one is to locate a licensed custodian. This is the person or institution that handles all the paperwork, helps you place the assets into the account, keeps you up-to-date on changes of value and quarterly reports, and makes sure you’re staying within the federal tax rules about what you can and can’t put into the SDIRA. Whether you want to rollover 401k to cryptocurrency or completely start from scratch, professional guidance is necessary.
The first challenge is to find a competent, honest, licensed custodian who can assist you in your SDIRA setup and who works with clients who want to put cryptocurrency into the accounts. The amount of paperwork is the same as for regular IRAs, so that part is not a problem. There are about two pages of forms to fill out, and that’s it.
You need to sign the forms, provide a valid ID, buy the cryptocurrency of your choice, and have the custodian place it into the account to get things started. Note that there’s also the matter of how to store the alt-coin. It’s usually best to work with a custodian who uses cold, offline wallets for the best level of safety and security.
Another consideration you’ll need to make is whether to work with an active or passive custodian. Active ones might charge a slightly higher fee. Still, they do all the paperwork, send regular statements to you, purchase cryptocurrency at your request, and take care of other secretarial-type tasks.
Passive custodians get the account going and hand you total control over ongoing maintenance. If you use a passive custodian, you have the option to make deposits of assets into the SDIRA whenever you wish, without the need to contact the custodian.
Most people who have SDIRAs that include cryptocurrency enjoy having the diversification option, the chance to own an asset that can act as a hedge against inflation, and be protected from the potential downside of an economic meltdown.
During the COVID-19 crisis, alt-coins performed well, proving their value as a reputable asset class. Also, there is a historical precedent of crypto assets generally following a rising trend line concerning prices.
As time marches on, more and more consumers are using alt-coins as a means of exchange, which is a vital sign that crypto is here to stay. As a class, crypto outperformed both gold and the S&P 500 index throughout 2020, a crisis year by any definition.
What are the negative points of keeping cryptocurrency in a SDIRA? For starters, if you can’t deal with risk, then crypto is probably not a wise way to go. The price volatility is for real and likely will continue for some time.
Second, there’s the tax situation. When you pull money out of a crypto-based SDIRA, you will not pay ordinary income-tax rates but long-term capital gains rates. Plus, there can be more fees associated with crypto-based and traditional IRAs. Why?
Crypto is still a unique asset, and the custodian often has to find a willing seller for the alt-coin you wish to buy. There are additional security tasks to keep the crypto asset safe from hacking and special reporting for tax purposes.
SDIRAs: Essential Things To Know
The good news is that it’s no harder to set up a crypto-based SDIRA than to start a regular, traditional retirement account. There are some differences concerning rules and such, but the process itself is not a challenge. Anyone can do it. If you choose to create your own alt-coin SDIRA, follow these steps:
✔ Study the specific coins you intend to put in your IRA. For example, if you decide to select Ethereum, Litecoin, and Polkadot, spend several hours researching their price histories, capitalization rates, and overall stability. Note that those three coins are just chosen as hypothetical examples. You can select more or fewer and from hundreds of leading cryptos out there.
✔ Find out how crypto-based, self-directed IRAs operate. Find a licensed professional who can assist you get all the preliminary paperwork taken care of. Additionally, be sure to work with someone who has experience in the alt-coin market and has a customer service attitude. You can read more about the best crypto self directed IRA professionals right here.
✔ Know the upside and downside of investing in crypto. The list of pros and cons is a long one, on each side. Yes, the growth potential is extremely high, but prices are pretty volatile, and you could suffer significant losses as well, even if they are temporary.
✔ As long as you take the time to study the good and bad aspects of this new asset class, you’ll be better prepared for whatever happens in the future. However, if your main goal is to diversify your retirement portfolio, cryptocurrency can be an effective tool for doing so.