Avoiding paying taxes is illegal, but there are legal ways to avoid triggering taxable events while holding your cryptocurrency holdings: Roth IRAs. These are Individual Retirement Accounts (IRAs) with a special type of tax relief system.
Using IRAs to avoid triggering taxable events with cryptocurrency investments is a strategy that has been under consideration for some time, with North American mining and hosting company Compass Mining last year offering a solution for BTC users to directly mine. their IRA.
Before we delve into it, 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-advantageous investment vehicles. Often, stocks with significant exposure to Bitcoin, 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. What sets Roth IRAs apart is that what investors place in these savings accounts can grow tax-free and be withdrawn without further tax being owed after the age of 59 and a half, if the account has been open for at least five years. .
In essence, a Roth IRA believes that because taxes have been paid on funds paid into the account, investors do not have to pay additional taxes as long as they meet the specific conditions outlined above.
Roth IRAs can be funded in a variety of ways besides regular contributions, which must be made in cash. Permitted assets 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 these are various Bitcoin IRA solutions designed to allow investors to save cryptocurrencies in these accounts. It is worth pointing out that annual contributions to Roth IRAs are limited according to the specific IRS and that investors can keep Roth IRAs for as long as they want, as no minimum distributions are required.
Is it a good idea to add cryptocurrencies to a Roth IRA?
Cryptocurrencies are known to be extremely volatile, which means they are not suitable for all investors. More conservative investors will likely be happier to hold bonds, mutual funds, and exchange-traded funds, while investors with a greater appetite for risk might consider allocating to cryptocurrencies.
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 increases accessibility and new cryptocurrency-related products and services are created. . This growth potential, it is worth pointing out, carries an increased risk.
Since Roth IRA tax-free withdrawals require accounts to be at least five years old, cryptocurrency investors looking to take advantage of them should always be prepared to hold their funds for a long time.
Chris Kline, co-founder of the Bitcoin IRA cryptocurrency IRA platform, 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 cryptocurrencies, a Roth IRA could be an attractive choice for those looking to take advantage of the promised long-term digital asset offering.”
For Kline, cryptocurrencies “will disrupt the very fabric of our daily lives in ways like the Internet has disrupted communications and emails have disrupted the post office.” The Bitcoin IRA co-founder added that while real estate and gold have been prime examples of diversification in the past, cryptocurrencies have “established themselves as an alternative in the modern economy.”
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Kline added that cryptocurrencies can offer an “alternative path for people of all ages” and that there has been a surge of interest in investing in crypto assets for diversification.
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 earn money, ideally they shouldn’t get into extremely risky businesses like cryptocurrencies.”
Otherwise, he added, “it defeats the idea of investing for retirement”. Sawhney warned that cryptocurrencies aren’t just Bitcoin (BTC) and that betting on them increases the risk of investors falling prey to Ponzi schemes.
As an investment category, he said, cryptocurrencies “may not be that bad” as these assets could become the “largest contributor to the overall Roth IRA amount when the contributor withdraws and plans to retire.” Once again, their potential outsized performance is measured against their risk.
For long-term investors who expect these outsized returns, putting cryptocurrencies into a Roth IRA allows them to realize their capital gains without being taxed, even if they will have to endure ups and downs for a while.
The extreme volatility of cryptocurrencies makes them a not-so-easy investment when it comes to retirement, with the jury wondering whether including cryptocurrencies in a 401 (k) retirement plan is solid 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, has been “long considered balanced and financially rewarding,” but suggested that cryptocurrencies are changing things:
“Now that an option is available to hold the relatively more volatile asset, cryptocurrency, a new strategy could be considered, for example 50/40/10. Here 10% could go to the new asset class that comprises cryptocurrencies. Investors should be able to change the allocation based on their risk appetite. “
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Due diligence, Sawhney concluded, is critical as Roth IRAs are often “seen as one of the best investment vehicles for young and low incomes.”
Speaking to Cointelegraph, Kevin Maloney, interim CEO at 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. cryptocurrencies “. He added that day traders could also benefit:
“For those who want to ‘trade daily’ due to the volatility of cryptocurrencies, an IRA still represents a solid option because they won’t pay annual taxes on their earnings as long as they don’t accept distributions.”
If investors are looking to add cryptocurrencies to their Roth IRA accounts, it is important to note that crypto assets are only available to these accounts via custodians, who can charge hefty 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 to long-term investors, as, since 2014, the IRS has taxed cryptocurrencies as ownership and capital gains taxes can be payable on depreciated assets.
The views and opinions expressed do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move carries risk, you should conduct your research when making a decision.