Should You Trade Bitcoin Through An IRA Account?

Bitcoin IRAs were among the earliest financial instruments to incorporate bitcoins. But they have received a mixed reception since introduction.

Proponents point to the tax benefits of trading using an IRA. Bitcoin trades typically incur a capital gains tax because the IRS has classified the cryptocurrency as real estate. Using a self-directed or Roth IRA, you can defer tax on such trades until a full withdrawal of funds from the account, which may occur several years or decades later.

But retail investors are still wary of the new asset class because of associated fees.

Among problems outlined by professionals is the absence of fiduciary responsibility for brokers and high fees associated with bitcoin trading at companies which offer this service. In some instances, some providers also saddle customers with the task of connecting disparate elements, from searching out exchanges for trading to ensuring custody for their service.

Equity Trust, a Cleveland-based financial services company which offers self-directed IRAs, recently launched a digital asset platform that provides retail customers with the facility to trade bitcoin through their IRA accounts. The company has partnered with Genesis Global Trading as a liquidity provider and Vo1t, a UK-based provider of custody solutions for cryptocurrencies.

Equity Trust charges an assortment of fees for cryptocurrency trading on its platform. These include a one-time enrolment fee of $500 and a $20 monthly maintenance fee along with a .07% asset-based fee for storage. Each bitcoin trade through their platform also comes with additional costs: 3.5% of the trade amount for purchase and 1% of the sale amount

The fee schedule for Equity Trust is significantly higher as compared to the maker and taker fees at various cryptocurrency exchanges and wallets. So why would anyone want to invest their hard-earned money into volatile crypto markets through an IRA?

Should You Trade Bitcoin Through An IRA Account?

Apart from an investor’s appetite for risk, profitability in bitcoin trades from an IRA account is a function of duration of investment and fees. The latter can especially negate the tax advantages of bitcoin trading offered by IRA accounts.

Allen from Equity Trust provides the example of an investor who purchased $50,000 worth of bitcoin on Nov 6th last year and sold it on December 11th, roughly coinciding with the period during which bitcoin’s price was beginning to take off. The $102,980 profit made by the investor during this period would come with a hefty $20,596 tax bill, assuming a 20% tax rate for high income-earners. Even assuming $3,310 in initial enrolment fees, the bitcoin trading investor would still be ahead by $17,286, Allen says.

Here’s a quick comparison of initial charges between three providers of bitcoin trading through IRA accounts based on estimates provided by them.

Of course, there are several considerations that you must take into account even after you begin trading.

The biggest one is the holding period for such transactions. The example provided by Allen reflects a best-case scenario, when valuations in cryptocurrency markets were hitting the roof. But prices for most major cryptocurrencies have crashed by more than 50 percent since the beginning of this year. A feasible strategy in a crypto winter is to hold onto your stash and hope for a change in weather conditions. That is when associated costs can add up.

As an example, let’s assume that the bitcoin investor from last year chose to hold onto his investment because so-called cryptocurrency experts predicted euphoric valuations this year.

Then the $50,000 bet on bitcoin last year would incur a $35 monthly charge for custody and a $20 monthly maintenance fee from Equity. That amounts to $660 in charges for a single year. The longer the holding period, the greater the amount accummulated through fees. Other charges, such as trading fees, further add to the overall bill.

For example, Equity charges 3.5% of total amount to process bitcoin purchases and 1% of overall amount for sale. Genesis Trading, the trading partner for Equity, charges its own commission to buy and sell bitcoin.

BitIRA, another provider, has an average 3% charge for trading in addition to the 1% charged by its bitcoin custody provider. Bitcoin IRA charges 5% as repurchasing fees for bitcoin while its trading partner has a $150 charge for each sale.

It follows then that the more frequent the trades within an IRA account, the more your charges. (There are no pattern day-trader restrictions within an IRA account but you cannot trade on margin in most cases). A sale to cut losses is also not beneficial within a Roth IRA because investors cannot claim deductions based on the loss amount.

That said, several providers of bitcoin trading through IRA accounts offer hefty discounts and sops to bring in new customers. For example, BitIRA’s initial charges vary between 5% to 15% of the investment amount as its account setup fee. The firm also offers promotions and discounts to individual customers. “We can work with you. We need to do a deep dive,” says Jay Blaskey, digital currency specialist at BitIRA. Bitcoin IRA, one of the earliest movers in the space, has three tiers for its setup fee and offers discounts in all three tiers.

The second caveat is the risks associated with cryptocurrency markets in their current avatar. For the most part, their regulatory status is unclear in multiple jurisdictions. Reports of crashes at cryptocurrency exchanges and scams haven’t helped endear cryptocurrencies to investors. In the absence of fiduciary responsibility for brokers facilitating such trades, those risks are transferred to investors.

The third caveat is the loss of immediate liquidity for investors. Profits from the sale will not be immediately available to traders. Typically, Roth IRA holders must wait until they are 59.5 years old to gain full tax advantages of the sale. Premature withdrawal of funds will incur a capital gains tax.

Investors in bitcoin IRAs should also inquire about access to private keys. Private keys allow you to access your bitcoin and are proof of ownership. In order to retain the tax-deferred status of IRA accounts, however, bitcoin custodians retain the keys until funds are withdrawn. Some services, such as Bitcoin IRA, offer key backup services. Access to private keys is important within the context of “in-kind” distributions or non-cash withdrawals from your IRA.

For example, Bitcoin IRA does not offer “in-kind” distributions, meaning that you cannot withdraw bitcoin as a digital asset. You will need to liquidate your position in the cryptocurrency and the firm will pay you cash from the sale amount. “In-kind” distributions can be useful for further investments in an asset that might appreciate in the future. Thus, you can request more bitcoin (or fractions of bitcoin) as your required minimum distribution (RMD) for a given year, instead of having the service provider send you a check for that amount.