Your Guide to Crypto Roth IRAs

Would you like to avoid hefty capital gains taxes while building wealth with cryptocurrency investments? Investing in a crypto Roth IRA might be one of the easiest ways to do this.

Roth IRAs are funded with after-tax dollars, so your investments can grow tax-free until you’re ready to withdraw them after retirement (but not before you reach the age of 59½). After that, all withdrawals made from your Roth IRA are completely tax-free.

Since regular crypto investments are subject to capital gains taxes, self-directed IRAs can be a great way to diversify your retirement savings and build your cryptocurrency portfolio in a tax-advantaged way.

What Are Crypto Roth IRAs?

The IRS has been taxing cryptocurrencies as property since 2014. This means, from a legal standpoint, they fall into the same category as stocks, bonds, and other investment assets.

You can’t place any of these investment assets (including cryptocurrencies) directly into your Roth IRA. This is because Section 408(a)(1) of the Internal Revenue Code of 1986 states that all contributions to an IRA must be made in cash.

So, to invest in crypto through your Roth IRA, you’ll need the help of a custodian. This is usually a financial institution tasked with keeping your IRA investments safe and complying with all government regulations.

The problem is that despite the growing popularity of cryptocurrencies, few custodians are willing to accept crypto in an IRA. However, you can overcome this problem by opting for self-directed IRAs, which are designed to hold alternative assets like cryptocurrencies.

A crypto Roth IRA, therefore, is simply a self-directed IRA that includes cryptocurrencies in its portfolio of assets. There are two main types of crypto Roth IRAs that you can invest in.

• Checkbook Roth IRA: With this type of IRA, you’ll have the freedom to invest in many different types of alternative assets, including cryptocurrencies. You can also diversify your investment portfolio with real estate, tax liens, gold and other precious metals, etc.
• Dedicated Crypto Roth IRA: This type of IRA is designed specifically for the purpose of investing in cryptocurrencies. So, if you open a dedicated crypto Roth IRA, you can’t use it to invest in any assets other than cryptocurrency.

Can You Stake Crypto in a Roth IRA?

Crypto staking involves pledging a portion of your digital coins to the cryptocurrency protocol for a given period of time. In exchange for this contribution to the blockchain network, you can earn additional coins or crypto tokens as a reward.

For the sake of simplicity, you can think of ‘staking’ as the crypto equivalent of depositing money in a bank. Just as you’d earn interest for locking up your money in a certificate of deposit (CD), you can earn rewards for locking up a portion of your crypto assets to confirm transactions on the blockchain.

Cryptocurrencies like Solana and Cardano – which use the proof-of-stake (PoS) model to process payments – require staking the most.

You can earn up to 5-20% staking rewards by opening a self-directed IRA LLC.

As of now, the IRS has not issued any specific tax guidance on staking transactions conducted through a Roth IRA. Crypto mining – which is an activity similar to staking in many ways – may be taxable within a Roth IRA and subject to unrelated business income tax.

Crypto Roth IRAs vs. Other IRA Types

Self-directed crypto Roth IRAs are just one among many different types of individual retirement accounts. Some of the other popular IRA options are:

Traditional IRA

This is one of the most popular types of IRA. In 2021-22, you can get an upfront tax break by contributing up to $6,000 in a Traditional IRA (or $7,000 if you’re 50 or older). In addition, all contributions made to a Traditional IRA are deductible, which can help lower your taxable income for the year. This type of IRA is perfect if you believe that your tax bracket during retirement will be lower than it is now. It’s also a good option if you don’t have access to a workplace-sponsored retirement plan.

Spousal IRA

This is the best IRA option for married couples where one of the spouses has either no or very low income. Typically, a person must have earned income to be able to contribute to an IRA. However, if you’re a stay-at-home parent married to someone who has a regular income, then you can use your spouse’s earnings to fund a separate IRA for each of you. The contribution limits are the same as for a Traditional IRA.

SEP IRA

The Simplified Employee Pension (SEP) IRA might be the best option for small-business owners who’d like to avoid the massive costs associated with starting and operating a conventional retirement plan for employees. SEP IRAs are set up and funded by an employer for their employees. The contribution limit in 2022 is $61,000, and the employer receives a tax benefit for the amount contributed. The contribution for each employee account is calculated as a percentage of salary.

The Difference – An Overview

The primary difference between the types of IRA mentioned earlier and a self-directed crypto Roth IRA is the types of assets or investments that can go into the account.

The traditional SEP and spousal IRAs typically allow only common investment vehicles like stocks, bonds, exchange-traded funds (ETFs), and mutual funds.

A self-directed crypto Roth IRA, on the other hand, can be used to invest in a wide range of cryptocurrencies like Bitcoin, Ethereum, Solana, Cardano, and many more.

Unless the self-directed IRA is dedicated solely to cryptocurrencies, you can also use it to invest in other alternative assets like gold, real estate, and privately held companies.

Another difference is that self-directed crypto Roth IRAs allow account holders to control their own investment decisions. In traditional SEP and spousal IRAs, on the other hand, all investment decisions are made by the plan administrators tasked with overseeing the account.

As a result, the holders of crypto Roth IRAs can take the reins of their own retirement planning and make investments in Bitcoin, Komodo, Ethereum, and other renowned as well as obscure cryptos.

Can You Use Your Roth IRA to Buy Cryptocurrency?

Yes, you can buy cryptocurrencies using your Roth IRA under the following conditions:

• You’ve opened a self-directed Roth IRA since most regular IRAs won’t allow crypto investments.
• The self-directed IRA is crypto-compatible, meaning that it either holds cryptocurrencies exclusively or along with other alternative assets.
• You’ve transferred funds to your IRA in cash and then used those funds to buy crypto. You can’t place crypto in a Roth IRA directly.

If you’d rather not deal with all the technicalities involved in the process of buying crypto through your Roth IRA, you can opt for a reputed full-service cryptocurrency IRA platform. These platforms will help make the process of investing in crypto through a Roth IRA much easier, safer, and more convenient.

Advantages of Crypto Roth IRAs

Investing in a crypto Roth IRA can provide you with three major benefits. We’ll discuss them in greater detail in this section.

Portfolio Diversification

Cryptocurrencies like Bitcoin and Ethereum are not tied to the stock market, so they can infuse your retirement portfolio with some much-needed diversification in the event of an economic downturn or stock market crash.

If your Roth IRA contains nothing but stocks and mutual funds – as is often the case with Traditional IRAs – then you might lose a significant portion of your retirement savings if the stock market were to falter.

Adding some alternative assets like crypto, gold, and real estate to your Roth IRA will help you stay financially stable even during a market downturn.

Tax Savings

As mentioned before in this article, Roth IRAs are funded with after-tax dollars. So, if you buy cryptocurrencies through your crypto Roth IRA, you won’t have to pay any capital gains tax on these trades.

This is because the funds in the Roth IRA had already been taxed before they were used to buy the cryptocurrencies. If cryptocurrencies experience significant growth in the future, this could result in huge tax savings for you when you’re ready to retire.

Growth Potential

If cryptocurrencies become more accessible and continue to grow in popularity over the next few decades, then they can prove to be an excellent investment for the future.

While many consider crypto to be a risky investment at present, they (and the blockchain technology on which they’re built) also present a chance for unprecedented growth and wealth creation. 

This is why more and more investors are choosing to grow their retirement savings by purchasing digital coins through a self-directed crypto Roth IRA.

Disadvantages of Crypto Roth IRAs

The primary disadvantages of a self-directed crypto Roth IRA are the risk and price volatility associated with cryptocurrency.

For most people, their retirement savings will determine their comfort and security during their senior years. Hence, the safety of the funds held in a Roth IRA is of great importance.

Self-directed IRA providers, however, are not bound by the broker fiduciary duties that usually hold Traditional IRA providers accountable.

So, it’s up to you as the investor to properly assess the risks and rewards associated with the crypto market. If you make a mistake in your assessment, you stand to lose a huge portion of your retirement savings.

Furthermore, most cryptocurrencies – including the biggest ones like Bitcoin – often experience extreme price fluctuations. This makes them an unsuitable investment type for retirement planning, especially if you’re close to reaching retirement age.

Is a Crypto Roth IRA Right for You?

To determine whether or not a self-directed crypto Roth IRA would be a good way to build your retirement savings, you need to consider a handful of factors.

• Age: Cryptocurrencies are a volatile asset that often experiences massive price fluctuations, so you should only invest in them if you’re young and have many decades before retirement. This is to ensure that a sudden fall in the price of Bitcoin won’t plunge you into poverty after retirement.
• Risk Appetite: Since cryptocurrencies are not the most stable and mainstream investment vehicle, you need to have a relatively large risk appetite to consider using them for your retirement planning. A crypto Roth IRA might not be the right choice for risk-averse investors.
• Knowledge: You should have a deep understanding and knowledge of the crypto market before setting up a self-directed crypto Roth IRA, as self-directed IRA providers are not bound by the same broker fiduciary duties that bind Traditional IRAs.