It's possible to invest in cryptocurrency in an IRA, but experts warn against it
Over the past year, interest in cryptocurrency has become much more mainstream, with the price of bitcoin, the largest by market value, surging to a record high in April.
With all of the hype, you might be wondering if it's possible — and worthwhile — to invest in cryptocurrency for retirement, specifically in your individual retirement account, or IRA.
It is possible through a self-directed IRA, which can be used to hold alternative investments normally not permitted in a traditional IRA, such as real estate or commodities. However, experts generally warn against it.
Here's why you should probably avoid investing in cryptocurrency for retirement.
'The costs can be sizable'
One reason experts warn against investing in cryptocurrency through a self-directed IRA is because they're not widely available and don't make sense for most investors. Generally, they can be both risky and expensive to maintain, even without cryptocurrency holdings.
There are also strict rules in place from the Internal Revenue Service regarding which investments are prohibited in IRAs. With a self-directed IRA, you manage all the investments yourself, so you're personally on the hook if any rules are broken.
"Self-directed IRAs usually require a specialized firm or custodian and the costs can be sizable due to the additional compliance and IRA requirements," Anjali Jariwala, certified financial planner, certified public accountant and founder of Fit Advisors, tells CNBC Make It. "[I]f you fail to abide by all of the rules, then your account may lose its tax-deferred status."
There's also the potential for fraud, as the Securities and Exchange Commission, or SEC, has previously warned. "While a broader set of investment options may have appeal, investors should be mindful that investments in self-directed IRAs raise risks, including fraudulent schemes, high fees and volatile performance," the SEC wrote in 2018.
"I would be really concerned with someone's decision to proceed," Jariwala says.
Crypto has its own risks
In addition to the risks of a self-directed IRA, Jariwala warns against investing retirement money in cryptocurrency specifically, due to its volatile and speculative nature.
Cryptocurrency investors generally need to be comfortable with extreme price swings and potentially losing their entire investment. For that reason, crypto may not be the best option in a retirement portfolio. It may make more sense as a relatively small portion of your overall portfolio since it can dramatically increase your portfolio's risk profile and potential drawdowns.
"I believe in diversification and prefer IRA-type accounts to be invested in the markets," Jariwala says. "If [an investor has] extra money that is in cash or sitting in a brokerage account, that may be used toward more speculative investments like bitcoin, but I wouldn't try to find a way to invest retirement money."
It's also important to consider the possibility for additional cryptocurrency regulation before adding it to your self-directed IRA.
"Currently, crypto is viewed as property, but if the IRS changes the asset type, it may become one that cannot be held in a self-directed IRA," Jariwala says. If that happens, "you might be stuck and forced to liquidate at an unfavorable time or face severe tax issues."
If, despite the risks, you still want to invest in cryptocurrency, try starting with an amount you can afford to lose outside of your retirement savings. Allocating a smaller portion of your overall portfolio can assist in hedging risk, while also giving you exposure to cryptocurrency assets.
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