You may have heard about people investing in Bitcoin and other digital currencies with their retirement account.
But why hold such a volatile asset like Bitcoin in a retirement account?
The short answer: Tax breaks.
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If you sell an investment inside an IRA, you wont owe taxes until you withdraw the money.
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But self-directed IRAs arent right for the average investor or even the average crypto investor.
Read on to learn how these accounts work to see if a self-directed IRA is right for you.
Did you know?
A self-directed IRA is a unique individual retirement account that lets you put your money in alternative assets.
Examples of alternative assets include:
Self-directed IRAs are intended for experienced investors.
People use these accounts to chase higher returns and diversify their retirement funds outside of traditional assets.
Self-Directed IRAs vs. Other IRAs
Self-directed IRAs arent like any other retirement account youve heard about.
Instead, custodians of these accounts are often banks or trust companies that specialize in self-directed IRAs.
To make things more complicated, you usually cant buy non-traditional assets directly from a self-directed custodian.
Instead, you must purchase them from another broker.
Your IRA custodian only holds these assets after youve purchased them.
Each custodian determines which investments it will accept.
Some custodians specialize in specific assets, like silver or Bitcoin, while others are more general.
In reality, these are self-managedIRAs that let you pick the traditional assets inside your account.
Thats not the case with self-directed IRAs.
From set-up fees to trading and account management fees, self-directed IRAs arent cheap to open or maintain.
Before you open one of these accounts, its essential to understand the costs and fees involved.
These costs can quickly add up, cutting into your IRA funds and earnings.
Tax Treatment
Tax breaks are a big reason investors choose self-directed IRAs.
When you set up one of these accounts, you might opt for a traditional or Roth version.
Growth within the account is tax-deferred.
When you withdraw money later, distributions are taxed as ordinary income.
With aRoth IRA, contributions dont qualify for tax deductions.
However, you get to enjoy tax-free withdrawals when you take money from your account down the road.
Custodians arent allowed to provide financial advice.
How Do You Buy Bitcoin With a Self-Directed IRA?
Bitcoin IRA is also the name of a company that specializes in these types of retirement accounts.
More online platforms are offering Bitcoin IRA services, including iTrustCapital, Coin IRA and BitIRA.
However, nearly all of these platforms still charge high fees like other self-directed custodians.
These specialized Bitcoin IRAs are complex.
However, custodian companies like the ones mentioned above take care of most of the paperwork.
After opening your account, a limited liability company is created, which the IRA owns.
it’s possible for you to then pick your digital assets through the crypto exchange of your choice.
Heres how it works.
Some IRA custodians have simplified the process for investors.
For example, IRA Financial Group has integrated with Gemini, a leading cryptocurrency exchange.
Theyre complex, not widely available and expensive.
They simply dont make sense for the average investor.
Here are three other reasons to think twice about using retirement savings to invest in cryptocurrency.
Regular IRAs are quick and easy to set up.
Custodians are plentiful and fees are minimal.
Plus they enjoy the same tax perks as a self-directed IRA.
Given all those fees, your account would need to make significant gains to justify the investment.
That makes buying a risky investment like cryptocurrency even riskier.
Most experts recommend allocating no more than 10% of your entire investment portfolio to speculative assets like cryptocurrency.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.
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