CryptoIRA vs Active trading: Which one is for you? [Video]

There are only two options for those wanting to trade crypto - directly buying and selling the cryptos themselves and using wallets and electronic safes - or buying and selling within a self-directed IRA.

In this video, we’re going to look at these options and run through the pros and cons of each.

Each has advantages and disadvantages - and, as with all investments - these are guided by your personal circumstances, appetite for risk, and how often (and how much money - either fiat or crypto) you need access to - and how quickly you need it.

A Bitcoin IRA is a type of self-directed IRA. These self-managed pension accounts let you invest in alternative asset classes such as real estate, precious metals and now crypto-monetary assets that are prohibited from traditional IRAs.

IRAs are unique to the US, and self-directed IRAs allow Americans to acquire a large range of alternative assets under their umbrella.

This is a great analogy because this is exactly what self-directed IRAs do - they shelter the holder from tax like an umbrella would shelter them from rain or sunshine.

All the asset classes you can invest in have degrees of risk. Holding them in an IRA does not, in any way, change this risk profile. The IRA simply makes the investment more tax efficient.

As always, there is a risk/reward calculation to make - investing in Bitcoin for retirement, for example, can improve your return on investment and give greater diversity, but it also significantly increases the risk to the returns in your pension portfolio.

One of the major stumbling blocks with alternative assets - even if approved by the IRS - is that many traditional financial institutions, like banks, will not allow their customers to use instruments like gold and crypto because they cannot earn fees so easily.

This is why those in the know are keen to diversify into crypto’s because every penny earned in fees and commissions is a penny less in the investor’s retirement fund. With portfolios that are worth a lot of money, such fees and commissions can take a substantial chunk from the investment.

In a recent survey, the Retirement Industry Trust Association reckoned that between 95 and 98% of IRAs were invested in traditional assets such as stocks and shares and bonds. This, of course, means that just 2 to 5% of IRAs are in alternative assets.

A crypto IRA generally operates like a conventional IRA except, instead of mutual fund shares, you are investing your money in bitcoin or other cryptocurrencies approved by the IRS as suitable investment vehicles.

You can pick between conventional self-directed IRAs and Roth IRAs and utilize their tax advantages. If you are 50 or older in 2021, you have a  yearly contribution limit, $6,000 or $7,000.

You can choose SEP, Simple IRAs and 401(k)s, which have much greater contribution limits if you are a self-employed or small business owner. You may even transfer money (called a “rollover”) from a conventional IRA to a self-directed IRA.

With a Bitcoin IRA, even more so than a normal IRA, you may have to be a bit more "DIY" in your approach. By this we mean that most brokers are a one-stop shop where you can buy and sell securities and set up your IRA in one place.

With a Bitcoin IRA you will need to have a custodian. The custodian will hold the IRA and is accountable for its security and safekeeping. The custodian also make sure that you comply with the IRS and government regulations. With a "normal" IRA this is dealt with by a bank or other financial institution.

You will need an exchange to manage your cryptocurrency trades. These digital currency exchanges or DCE's, act in the same way as the stock market. They enable you to buy and sell your cryptocurrency. Make sure that the exchange you pick deals with Bitcoin, Ethereum or whichever coin(s) you have.

Finally, you will have to keep your cryptocurrency in secure storage. Luckily, most providers of cryptocurrency IRAs will include a secure storage method in their package. Often these are fully insured for even more peace of mind.

Your chosen self-directed IRA provider should be able to deal with all of these points, either in-house or by partnering with an exchange or letting you trade with a third party.

So, what are the advantages of Bitcoin IRAs?

Cryptocurrencies allow much greater diversification than a normal portfolio. Because there is no correlation between cryptocurrency and, say, stocks, or bonds, investors will get a different set of returns at different points in the market cycle. 

Cryptocurrencies are known to be volatile in price, and this opens new opportunities to trade that volatility – an opportunity which would not be available with the assets that most Americans hold in their retirement accounts.

As you'll know, even if you have only vaguely followed cryptocurrencies up to now, the potential returns on cryptos are astronomical. Aside the volatility, the potential for growth in the short, medium, and long-term is promising. 

For example, Bitcoin was $5200 in March 2020, and finished the year at almost $30,000. Ethereum gained 400% over the same period of time. Because of the inherent risk in crypto, you should only invest a small percentage of your overall IRA value in these instruments.

Anyone who has held any form of cryptocurrency will know that the biggest headache is keeping track of trades and working out what taxes might be owed to the IRS. Taxes are due on any profitable cryptocurrency trade. 

Working out the gains when prices are so volatile is almost a full-time job for those who trade often. By using a tax advantaged traditional or Roth IRA you can defer all taxes while the cryptocurrency is held within your account. 

As a final bonus, you will get the compound growth of the amount you would have paid in taxes. Over the course of the life of a typical IRA this amount will be substantial.

And what are the disadvantages of crypto IRAs?

Risk, of course. All cryptocurrencies come with a high degree of risk. This makes them unsuitable investment vehicles if you are close to retirement. If cryptos took a sudden massive downturn there may not be time to recuperate your losses before having to draw down your pension.

One huge disadvantage of crypto IRAs over normal IRAs' is fees. Are normal IRA will usually let you invest for free – with self-directed IRAs there are often setup fees, account management fees and trading fees. Always find out the costs involved before investing in a cryptocurrency IRA.

If you have been involved in crypto for some time you may have a favourite crypto exchange. Not all Bitcoin IRA companies, for example, allow you to use your choice – they will only let you trade with their own affiliated currency exchanges. If you want to use a specific exchange check that the IRA provider allows this.

The volatility of crypto currencies is another disadvantage (if the price is going wrong). Bitcoin went from $20,000 in 2017, to $3,400 in 2018. Make sure you can handle this kind of volatility if you are going to go crypto.

Where a normal taxable investment account has losses, you can deduct these from your profits to offset any gains. Unfortunately, this is not possible within a Bitcoin IRA as they are tax-advantaged anyway. So you will only gain if your cryptos rise in price.

If you've watched this video so far you'll be aware of another disadvantage of crypto's -  their complexity. keeping on top of secure storage, exchanges, custodians and trading accounts is almost a full-time job. If you invest in a Bitcoin IRA, the chances are you'll need a separate retirement account for any traditional assets like mutual funds bonds and stocks you may have.

Finally, make sure that you do your due diligence – you can never know too much about cryptocurrencies and the way they work.