As the cryptocurrency market matures, more and more governments around the world are introducing legislation to tax the proceeds of crypto-related activities, with traders often triggering taxable events that can result in future complications.
Avoiding paying taxes is illegal, but there are legal ways to avoid triggering taxable events while retaining your cryptocurrency holdings: Roth IRAs. These are Individual Retirement Accounts (IRAs) with a special type of tax-advantaged regime.
Using IRAs to avoid triggering taxable events with cryptocurrency investments has been a strategy that has been considered for some time, with North American mining and hosting company Compass Mining offering a solution for BTC users to mine directly their IRAs last year.
Before we dive deeper, it’s important to point out that Roth IRAs are only available in the United States, although other countries often have their own form of tax-advantaged investment vehicles. Often, stocks with high Bitcoin exposure – such as MicroStrategy – need to be used as a proxy for some of these vehicles.
What are Roth IRAs?
A Roth IRA is a type of individual retirement account to which investors contribute after-tax income. What sets Roth IRAs apart is that what investors put into these savings accounts can grow tax-free and be withdrawn without further tax owing after age 59½. , if the account has been open for at least five years.
Essentially, a Roth IRA considers that since taxes have been paid on the funds contributed to the account, investors need not pay additional tax as long as they meet the specific conditions outlined above.
Roth IRAs can be funded in a number of ways beyond regular contributions, which must be made in cash. Assets allowed in Roth IRA accounts include stocks, exchange-traded funds, money market funds, bonds, mutual funds, and cryptocurrencies.
The Internal Revenue Service (IRS) does not allow direct cryptocurrency contributions into these accounts, but there are various Bitcoin IRA solutions designed for investors to save cryptocurrency into these accounts. It should be noted that annual contributions to Roth IRAs are limited based on IRS specifications, and investors can hold Roth IRAs as long as they wish, as there are no required minimum distributions.
Is it a good idea to add crypto to a Roth IRA?
Cryptocurrencies are known to be extremely volatile which means they are not suitable for all investors. More conservative investors are likely to be happier holding bonds, mutual funds, and exchange-traded funds, while investors with a higher appetite for risk might consider allocating to crypto.
The growth potential of cryptocurrency holdings in a portfolio is enough to attract investors who believe that cryptocurrencies will continue to grow in popularity as the infrastructure around them improves accessibility and new products and cryptography-related services are created. With this growth potential, it should be emphasized, comes increased risk.
As tax-free withdrawals from Roth IRAs require accounts to be at least five years old, cryptocurrency investors looking to take advantage should always be prepared to hold onto their funds for a long period of time.
Chris Kline, co-founder of IRA cryptocurrency platform Bitcoin IRA, told Cointelegraph that there are no tax benefits on contributions to Roth IRA accounts, but there are tax benefits on distributions:
“If you have a longer time horizon in bitcoin and crypto, a Roth IRA could be an attractive choice for those looking to take advantage of the promising long-term supply of digital assets.”
For Kline, cryptocurrencies will “disrupt the very fabric of our daily lives in ways that the internet disrupts communication and email disrupts the post office.” The Bitcoin IRA co-founder added that while real estate and gold were prime examples of diversification in the past, crypto has “asserted itself as an alternative in the modern economy.”
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Kline added that cryptocurrencies can provide an “alternative path for people of all ages” and that there has been renewed interest in investing in crypto assets for diversification purposes.
Kunal Sawhney, CEO of equity research firm Kalkine Group, appears to disagree with Kline’s approach. Speaking to Cointelegraph, Sawhney said that if a person has “spent time and work to make money, ideally they shouldn’t go into extremely risky assets like cryptocurrencies.”
Otherwise, he added, it “goes against the idea of investing for retirement”. Sawhney warned that cryptocurrencies are not just Bitcoin (BTC) and betting on them increases the risk of investors falling prey to Ponzi schemes.
As an investment category, he said, cryptocurrencies “might not be so bad” because these assets could become the “biggest contributor to the overall Roth IRA amount when the contributor retires and is considering retiring.” Once again, their potential outsized performance is weighed against their risk.
For long-term investors who expect these outsized returns, putting cryptocurrency in a Roth IRA allows them to realize their capital gains tax-free, although they will have to endure the ups and downs for a while. time.
The extreme volatility of cryptocurrencies makes it a not-so-easy investment when it comes to retirement, with the jury wondering if including cryptocurrencies in a 401(k) retirement plan is good financial planning or gambling with the future.
For Sawhney, investors must have a predetermined strategy for their Roth IRA. The CEO noted that a 60/40 portfolio, with greater exposure to equities than bonds, was “long considered balanced and financially rewarding,” but suggested cryptocurrencies are changing things up:
“Now that there is an option available to hold the relatively more volatile asset, cryptocurrency, a new strategy, say 50/40/10, could be considered. Here 10% could go to the new class of assets that include cryptos. Investors should have the ability to change the allocation share based on their risk appetite.”
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Due diligence, Sawhney concluded, is crucial because Roth IRAs are often “regarded as one of the best investment vehicles for young people and low-income people.”
Speaking to Cointelegraph, Kevin Maloney, interim CEO of crypto retirement account provider iTrustCapital, said volatility is actually “one of the main reasons why many investors prefer to use a Roth IRA or any other type. of IRA to invest in crypto”. He added that even day-traders could benefit:
“For those who want to day-trade due to the volatility of crypto, an IRA still represents a solid option as they won’t pay annual taxes on their earnings until they take distributions. “
As investors seek to add cryptocurrencies to their Roth IRA accounts, it is important to note that crypto assets are only available for these accounts through custodians, who may charge high trading fees.
It is up to each investor to analyze which type of investment vehicle best suits their situation and risk appetite. Roth IRAs can be extremely beneficial for long-term investors because, since 2014, the IRS has taxed cryptocurrencies as property, and capital gains taxes may be due on impaired assets.
The views and opinions expressed do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.