On March 11, the United States Department of Labor warned employers who sponsor 401(k) retirement plans to “exercise extreme caution” when dealing with cryptocurrencies and other assets. even threatening to pay extra legal attention to retirement plans with large crypto investments.
His logic is familiar to any crypto investor: aside from the risk of fraud, digital assets are prone to volatility and, therefore, can pose risks to the retirement savings of American workers. On the other hand, we are seeing established players in the retirement market making moves towards crypto. For one thing, retirement investing platform ForUsAll decided last year to implement crypto as an investment option for fixed 401(k) retirement accounts in partnership with Coinbase. Is this the start of a larger trend?
Why even bother?
Besides the simplistic explanation that digital assets have the magical ability to make people extremely rich in a short period of time, there are two serious points to consider regarding crypto and retirement investing.
The first is the diversification of investments. At least for now, cryptocurrencies, non-fungible tokens (NFTs), and other digital assets possess relative autonomy from the broader traditional financial market. In some cases, this could make them relatively stable when stock markets and other traditional markets are in turmoil.
A second, perhaps more pragmatic point is that one does not have to pay the same amount of taxes when buying and trading crypto through a retirement plan. It’s a question of both profit and time – every time a US investor makes money selling cryptocurrency, they are required to record it to report to the Internal Revenue Service . Retirement accounts are generally exempt from this charge. As Dale Werts, a partner at law firm Lathrop GPM, explained to Cointelegraph:
“Trading crypto in a qualified plan would be treated like any other transaction of assets in a plan, so the same tax benefits would apply. Normally, transfers of assets within a plan are not taxed — that’s the whole point of a qualifying plan. The gains you accumulate can be kept tax-free until you take a distribution.
What the Law Says: 401(k)s, ERISA and IRAs
Given that 401(k) investments are subject to the Employee Retirement Income Security Act (ERISA) of 1974, it’s no surprise that digital currencies fall into a legal gray area when part of a portfolio. retirement investment. ERISA does not specify which asset classes can or cannot be included in a 401(k). Somewhat outdated, it requires trustees to “exercise the care, skill, prudence and diligence that a prudent person would exercise” when dealing with the hard-earned money of retirees. .
Nevertheless, the vast majority of employers prefer not to go against the spirit of the law; therefore, there are few opportunities to invest directly in crypto through 401(k) plans at this time. As Christy Bieber, a contributing analyst at investment advisory firm The Motley Fool, pointed out to Cointelegraph:
“Those who use a 401(k) to invest for their retirement will generally not have the option of buying cryptocurrencies when investing for their final years. That’s because 401(k) accounts typically limit you to a small selection of mutual funds or exchange-traded funds.
A common solution for those who are nonetheless keen to incorporate crypto into their retirement funds are self-directed Individual Retirement Accounts (IRAs), where the choice of assets to allocate is usually open.
The Retirement Industry Trust Association has estimated that between 3% and 5% of all IRAs are invested in alternative assets such as cryptocurrencies. According to various surveys, between 49% and 54% of millennials are invested in cryptocurrencies or NFTs and/or consider them part of their retirement strategy.
Werts, who includes crypto in his own personal retirement investing strategy, said that while the Department of Labor has highlighted the general risks and challenges of crypto, ERISA does not ban digital assets in any way. as an investment option in a 401(k) plan. He sees three main options for those interested in crypto as a retirement asset:
- “You can (if available through your employer) use a self-directed 401(k) to invest in alternative investments like cryptocurrencies. A simple Google search reveals at least one alternative to ForUsAll: BitWage. Many companies are also working on ETFs (like Vanguard and SkyBridge Capital), although the Securities and Exchange Commission does not yet approve any. There are Bitcoin futures investment options approved by the Commodity Futures Trading Commission.
- “You can invest in a long list of publicly traded companies that own crypto, like MicroStrategy, Tesla, Coinbase, Block, PayPal, Marathon Digital Holdings, and Nvidia. I did it. Of course, these companies have other business goals, so you have to “agree” with those goals, whatever they are.
- “You can invest through your 401(k) plan in trusts, like Grayscale Investments’ Bitcoin Trust and Ether Trust (which I invested in). It’s easy, and they’re like mutual funds or money market funds – you buy a “unit” of a trust, which is completely liquid, rather than a fractional interest in a particular cryptocurrency.
From 2% to 5%
Regulatory hurdles aside, the main argument against crypto in pension plans is still purely economic. Experts generally recommend that crypto not represent more than 5% of the retirement investment portfolio due to its volatility and the unclear regulatory outlook in the United States.
Bitcoin (BTC) is the perfect example of this volatility, as the #1 currency has lost around 30% of its market value since November 2021 and at one point lost almost 50%. This has nothing to do with the conservative momentum of the S&P 500: the index has posted a consistent average annual return of 13.6% between 2010 and 2020.
“Five percent might be the right amount for some investors, but it depends on your individual risk tolerance as well as your retirement schedule,” Bieber said, pointing out that the risk of losing everything in crypto assets is still much higher. high compared to investing in an S&P 500 fund. And the 5% mark is more suitable for younger investors, while older adults who will soon need to dip into their accounts may want to maintain their crypto allocation at 2% or less. Biber added:
“Ultimately, because of the significant risk cryptocurrencies present, you shouldn’t invest more of your retirement money in them than you can afford to lose. If putting 5% of your retirement money in digital currencies means you’ll end up with a nest egg that doesn’t provide adequate income, you should allocate far less of your money — or none at all — to this high-cost investment. risk. .”
Can crypto be more widely adopted by retirement investors, at least on a limited scale? Bieber thinks the scenario is possible if cryptocurrencies continue to gain mainstream acceptance among institutional investors, which would both lead to their spread to more conservative corners of the financial market and, in a somewhat virtuous circle , would make them less volatile. She commented:
“It is possible that if the SEC begins to regularly allow ETFs or mutual funds to buy cryptocurrencies directly, more funds could be created that would be dedicated to this asset class. And some could eventually be offered in 401(k)s. […] If cryptocurrencies continue to gain mainstream acceptance and many ETFs or mutual funds offer exposure to them, target date funds and robo-advisors may also begin to include these funds in portfolios. ‘they build.
There is no shortage of interest in crypto, but seeing stable future demand relies on a simple and accessible infrastructure that would benefit retired investors. This means the US regulatory community will have to update nearly 50-year-old pension legislation. In that context, the recent Department of Labor warning feels a bit like a band-aid and tells us more about the uncertain present than the future – and retirement plans, as we know, are all about certainty.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.