Back in 1999, when I first started teaching my method for creating synthetic bonds, by using options, with the goal of throwing off much higher cash flow than traditional cash flow investments, there were no brokerage firms that allowed you to buy or sell options in an IRA.
Options were perceived as really risky. Certainly not something people should be doing in their IRA! Not even covered calls! Even though a covered call is actually less risk than just owning the stock!
It wasn’t that they were prohibited. It was just a perception. A wrong-headed perception.
It took a number of years before optionsXpress became the first brokerage firm, who understood options well enough, that they began offering options trading in IRAs.
Not coincidentally, optionsXpress was a new firm, built from the ground up, that didn’t have the emotional baggage around options that the legacy brokers did.
And they were hungry. We sent hundreds of millions of dollars of client business to them as a result. And because they were an upstart, that business was meaningful to them.
Of course, within a few years everyone did it. But someone had to be the first to break with conventional wisdom. And that someone was optionsXpress.
In 2018, 67% of Americans say they will run out of money in retirement. That fact has not changed since I created the Snider Method and started teaching it to near-retirees in 1999 as a way to bridge that gap.
Fast forward 19 years and we are in a very similar situation. Only this time the boogey man in the closet is cryptocurrency.
The lopsided upside:downside potential of cryptocurrency is like nothing we have ever seen before. Or may see ever again. Which is why people think it is scary. Or a scam. And yet, it may be our single best opportunity to solve the retirement savings problem for an entire generation of near-retirees.
The risk isn’t investing in cryptoassets. It’s NOT investing in cryptoassets. The trick is to structure our investment so that, if the naysayers are right, we don’t do irreparable harm to our nest egg. But if the believers are right, we make potentially life-changing money that could catapult us across that retirement finish line.
In a perfect world, the most desirable place to make that investment, whenever possible, is in a tax-advantaged retirement account, like an IRA. Not only because of the tax consequences. But because that is where many near-retirees have the bulk of their investable assets.
So what are your current options for investing in Bitcoin in an IRA?
- Buy Greyscale Bitcoin Investment Trust (OTC:GBTC) in an IRA at a regular brokerage account
- A self-directed IRA at an IRS regulated trust company or “non-bank custodian”
- A “checkbook IRA” (a specific form of self-directed IRA also known as an IRA-LLC)
What is a self-directed IRA?
According to the IRS: A self-directed IRA is an IRA held by a trustee or custodian that permits investment in a broader set of assets than is permitted by most IRA custodians. Most IRA custodians are banks and broker-dealers that limit the holdings in IRA accounts to firm-approved stocks, bonds, mutual funds and CDs.
Custodians and trustees for self-directed IRAs, however, may allow investors to invest retirement funds in other types of assets such as real estate, promissory notes, tax lien certificates, and private placement securities
What investments are allowed in a self-directed IRA?
The IRS does not provide guidance on what is permitted, but specifies only what is NOT permitted. This includes life insurance policies, shares of an S Corporation and collectibles.
The IRS definition of “collectibles” is fairly straightforward, but there are some exceptions that it is important to note. Collectibles include artwork, rugs, antiques, metals, gems, baseball cards, stamps, alcoholic beverages, and most coins.
Exception for certain coins and precious metals
Per IRS Pub 590-a: “Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.”
Examples of assets commonly held in self-directed IRAs
It is up to each IRA custodian to determine what assets they will or will not custody in self-directed IRA accounts.
Common examples include: Precious metals as per the exception above, real estate, secured & unsecured notes, private company stock (including LLCs), tax liens & deeds, judgments & structured settlements, accounts receivable factoring, commercial paper, equipment leasing and, as of more recently, bitcoin and other cryptoassets.
What is a “checkbook IRA”?
In the 1996 case of Swanson vs. Commissioner, the tax court gave its blessing to a new type of self-directed IRA structure — sometimes known as a checkbook IRA or IRA-LLC .
In the case of an checkbook IRA, your IRA does not own the individual assets. It owns one asset: a single member LLC. As manager of the LLC, you are able to buy and sell assets within and on behalf of the LLC for the benefit of your IRA. You have checkbook control, hence the name checkbook IRA.
Why is a checkbook IRA better than a traditional self-directed IRA?
While for some people a traditional self-directed IRA may suffice, the biggest advantages of the checkbook IRA are: lower fees, fewer restrictions and more control.
In 2014, when the IRS issued it’s guidance on virtual currency, confirming that it was considered property and could therefore be held in an IRA, an entire cottage industry sprung up of so-called “Bitcoin IRAs”.
In spite of the fact that SDIRAs had been around for ages, (I set my first one up around 2001), these early marketers of “digital asset IRAs” charged outrageous fees (ie. $3000 setup plus 10% commission plus % of assets for maintenance!) and huge minimums in order to take advantage while they could. Shockingly, they are still out there and people are still falling for them.
More recently, established custodians like Kingdom Trust and Pensco have gotten into the game with fees that are more in line with those for other assets. But still, those fees are not inconsequential. And one could argue justified since they have to custody your cryptoassets, which requires additional cost and expertise.
Plus, literally every time you get permission from the custodian to buy or sell, there is a fee. Every wire transfer, or check cut, or report filed … another fee. Granted it’s a lot of $200 here and $50 there. But over time, it really adds up.
With a checkbook IRA, especially if you set it up with a custodian that only charges a flat annual fee, not a percentage of assets plus transaction fees, as most do, you take fees of what could be thousands of dollars per year down to $275 or less.
This is possible because you, or more accurately the LLC you manage, has custody of the cryptoasset AND you are not required to consult with the custodian for each purchase. You can buy and sell at will from the LLCs bank/brokerage accounts.
In fact, with an checkbook IRA, you don’t even need a custodian that allows Bitcoin. You just need a custodian that allows single member LLCs, as that is the only asset owned by your IRA. What you buy and sell is your business, so long as it is within the IRS rules.
Which, of course, brings me to the admonition that with great power comes great responsibility. The trade-off is you don’t have someone else responsible for not losing your cryptoassets or making sure that a transaction won’t blow up your IRA or any of a number of other services provided by the custodian of a traditional IRA.
Moreover, the consequences of a mistake can be significant, as we will see in a later section. But first, let’s get into the weeds…
What are the steps for setting up a checkbook IRA?
- Open self directed IRA at custodian that allows single member LLCs, preferably one that charges a flat annual fee only
- Roll funds/assets from existing IRA to new self-directed IRA — rollovers are a custodian to custodian transfer, not a distribution, and therefore not taxable.
- Set up single member LLC with your IRA as the single member and you as the manager — Most custodians will have specific language required in the LLC operating agreement
- Get an Employer Identification Number (EIN) for your LLC — this is analogous to a Social Security Number but for companies
- Complete Direction of Investment instructing custodian to send a check to the LLC
- Set up business bank account for the LLC and deposit check sent by custodian
- Open accounts at exchanges in the name of the LLC — this can be a lengthy and tedious process with quite a bit more paperwork than an individual account but it is critical the account be a business account in the name of the LLC, not your name
- Connect LLC bank account to LLC exchange account
- Purchase cryptoassets
- Transfer cryptoassets from exchange to hardware wallet bought specifically for the LLC — my recommendation is a Ledger Nano S. Others are Trezor and KeepKey.
- Store digital wallet and 24 word seed phrase in safe place
- Complete the Letter To Loved Ones template (courtesy of Pamela Morgan) telling your loved ones what, where and how to access your cryptoassets if anything should happen to you.
What are prohibited transactions in a self-directed IRA?
Your IRA may not buy an investment from or sell an investment to a disqualified person as defined by Internal Revenue Code Section 4975. To do so is known as “self dealing”.
Disqualified persons are individuals or entities between whom or which an IRA is prohibited from engaging in any direct or indirect sale or exchange or leasing of any property; lending of money or other extension of credit; furnishing goods, services or facilities; or transferring to or permitting the use of IRA income or assets.
Disqualified persons include:
- Fiduciaries (which in the case of a self-directed IRA includes you, as the IRA owner);
- Your spouse;
- Your parents;
- Your grandparents and great-grandparents;
- Your children (and their spouses);
- Your grandchildren and great-grandchildren (and their spouses);
- Service providers of the IRA (e.g., IRA custodian, CPA, financial planner);
- An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly or held by a fiduciary or service provider; also a partner which holds 10% of a joint venture of such entity.
The general rule is that neither you or these people/entities close to you can benefit from or do business with the IRA-LLC.
What are the consequences of a prohibited transaction?
Per the IRS: Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year.
If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you will have a taxable gain that is includible in your income. The distribution may be subject to additional taxes or penalties.
Some other “gotchas” when setting up a checkbook IRA for purchasing cryptoassets
One is Unrelated Business Income or UBIT. While a thorough discussion of UBIT scenarios is outside the scope of this article, the one scenario most likely for an IRA investing in cryptoassets is the use of debt financing through margin. Do not buy on margin in a checkbook ira.
The other comes into play if you open an account at a non-US bank or brokerage firm. Again, per the IRS:
If you have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds, the Bank Secrecy Act may require you to report the account yearly to the Department of Treasury by electronically filing a Financial Crimes Enforcement Network (FinCEN) 114, Report of Foreign Bank and Financial Accounts (FBAR)
Services that will set this all up for you
If you have the time, temperament and experience to set this all up yourself, it can be done.
On the other hand, the safest bet, especially if this all left you feeling really overwhelmed, is to pay a professional to do it for you. Depending on the size of your investable assets, the fees charged may be well worth it.
My advice, if you do choose to go the done for you route, is to not go with your local accountant or attorney unless they just happen to have expertise in both cryptocurrency and tax. Find professionals who specialize in these areas.
They will be less expensive because they have done it before and they just cookie cutter the documents. They will have relationships with custodians and brokerage firms that speed up the process. And they are less likely to make a mistake which will cause you, at best, to pay for something twice and, at worst, nullify your IRA.
As a rule of thumb, if you are paying more than $2000 to have all this set up for you, you are paying too much. Over time, as cryptocurrency becomes more and more mainstream, that number should also come down.
In fact, we probably aren’t too far off from the day traditional brokerage firms, like Fidelity, begin offering cryptoassets to their clients. Until then, while there is definitely a cost in time and money to set this all up initially, if you believe in cryptoassets as an asset class, as I do, then putting that in an IRA may be well worth it.
Just something for you to consider and, as always, I hope you found it helpful.
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If you’d like to learn more about investing in cryptocurrency for retirement, I would encourage you to register for my free online training, How A Little, Little Bit of Bitcoin Can Make Your Retirement Savings Go A Lot, Lot Further.
If you have any questions at all, about this topic, or anything else, just email me at firstname.lastname@example.org. I read and answer every email personally. Or leave it in the comments below.
I am not a financial advisor, CPA or lawyer. This is not investment advice, tax advice, or legal advice. Please consult with a qualified professional before making any investment decisions.
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