Investors are debating whether to hold or not to hold cryptocurrency in their IRAs or 401(k)s ahead of Wall Street's traditionally volatile fall season.

By Gregg Greenberg

Farewell to crypto winter and all its discontent. But what does crypto fall hold for retirement savers? Should they expect a comedy or another tragedy in the coming months?

As the stock market enters the traditionally volatile fall season, investors are facing their own Shakespearean decision on whether to hold or not to hold cryptocurrency in their individual retirement accounts or 401(k)s.

Crypto blue-chip bitcoin, for example, has spent the summer being as indecisive as Hamlet, bouncing between $20,000 and $25,000 a coin. For so-called “diamond hand” holders, bitcoin’s lack of direction for a few months is inconsequential. In their view, the future remains golden and, if anything, the range-bound trading over the summer can be seen as a consolidation phase in bitcoin’s inevitable march higher.

Nevertheless, for investors who don’t see bitcoin’s 67% swan dive from last November’s high through blockchain-tinted glasses, there are decisions to be made. And as Wall Street traders return home from the Hamptons and the leaves start to change, now’s the time to make them.

That’s especially true when it comes to owning crypto in retirement accounts, where the stakes are higher for those seeking to enjoy their golden years without worrying about a similar sell-off. Or, even worse, losing their digital currency to hackers, heirs or history if it’s improperly stored.

BE WARY THEN, BEST SAFETY LIES IN FEAR (HAMLET)

The security of crypto wallets and exchanges has substantially improved as blockchain technology has evolved, along with authorities’ ability to track down digital thieves. That said, if one’s crypto-assets are lost or stolen, there’s generally no way to recover those funds. The speed and anonymous nature of the currency simply make it too difficult.

The safest way to store crypto-assets is offline, meaning not connected to the internet, which greatly reduces the threat of hacking.

“If you follow the stories of crypto theft and hacking, many such attacks happen on crypto exchanges or wallets, which are accessible online. The preferred method of storing crypto is when it is physically severed from the Internet and the pathway for thieves to access the crypto. This is known as ‘cold’ storage, in contrast to ‘hot’ wallets, which are accessible online,” said Asher Rubinstein, partner at Gallet Dreyer & Berkey.

One preferred method of storage is in a hardware wallet, which holds the crypto-assets as well as the keys to the crypto and is physically severed from the internet. When it comes to estate planning, Rubinstein said people often transfer their assets to a trustee whose role it is to care for and keep these assets safe. This means transferring the crypto to the trustee’s own wallet or providing the trustee with the address of a wallet, as well as the keys.

“There are professional crypto trustees and custodians who are well-versed in holding and safeguarding crypto-assets,” he said. “For example, clients may set up an offshore asset protection trust and fund the trust with crypto-assets, with the crypto transferred to a ‘cold storage’ facility deep in the Swiss Alps.”

TO HAVE A THANKLESS CHILD! (KING LEAR)

Speaking of safeguarding assets, an investor’s heirs need to know where the crypto is located, lest it be lost to history. Banks and other financial institutions provide account statements and 1099 forms, so children and grandchildren often have such road maps to the assets. However, many crypto custodians, including foreign exchanges, don’t provide statements.

“If one’s crypto is on a small hardware device, how will the heirs know where to find it? So when contemplating one’s estate, one must also leave details about the crypto, including where the crypto is stored as well as the private keys to access the crypto,” Rubinstein said.

Moreover, crypto-assets are generally better suited to trusts than to wills, which go through the very public process of probate. Probate also provides a venue for a challenge to the will and its terms, once again potentially exposing those crypto-assets for lawyers, courts and others to see (And we all know what Shakespeare thought of lawyers!).

Trusts avoid probate because assets are transferred to the trust during one’s life, and after death the trust has a continuing duration of its own.

“By using trusts, people with significant assets usually avoid public disclosure and potential estate challenges,” Rubinstein said. “Trusts also allow a trustee immediate access to trust assets without having to wait for approval and appointment by a probate court. Trusts can also provide better asset protection for trust assets and claims against trust beneficiaries.”

(Note to King Lear. Don’t turn over the keys to your crypto kingdom until you’re long gone!)

A HEAVY RECKONING FOR YOU (CYMBELINE)

The IRS considers crypto to be property, and thus crypto is potentially subject to taxation like other forms of property. (For the record, Shakespeare was a notorious tax cheat.) Bitcoin, like any other form of property, is taxed when it is sold, gifted or creates income. Therefore, crypto can be subject to income tax, gift tax and estate tax.

“Crypto investing can be tax-inefficient, subjecting active traders to short-term capital gains. Investors intent on owning shorter-term or trading may want to do so in qualified accounts, particularly Roth IRAs,” said Mark Pniak, senior director at Choreo. “However, many traditional custodians don’t currently support crypto, requiring investors to find a suitable specialty IRA platform, which adds another level of complexity.”

Non-fungible tokens of artwork or photographs, however, are a different story.

“NFTs are usually bought with crypto, and the investor has at least three potential tax events: First, the gain in value from when you bought the crypto and exchanged it for the NFT. Second, the gain in the NFT’s value when you sell it. Third, if the NFT itself generates income, then each payment is also reportable and taxable,” Rubinstein said.

Gerber Kawasaki Wealth & Investment Management was one of the first wealth management firms to offer direct crypto exposure to clients. However, the firm doesn’t advocate adding crypto to retirement accounts, primarily because of the tax treatment.

“Given that crypto is not subject to wash-sale rules, we recommend exposure in a taxable account. This allows us to help clients potentially harvest losses and immediately rebuy, which adjusts their cost basis with the ultimate goal of taxation being a long-term capital gain,” said Zach Bainter, managing partner at Gerber Kawasaki.

Bainter added that he also advises against putting digital currencies in client IRAs due to its relatively risky nature.

“It is our viewpoint that the possibility of a crypto asset going to zero is too much of a risk and potential setback to a client’s retirement plan,” he said.

Rayhaneh Sharif-Askary, managing director at crypto product provider Grayscale Investments, views crypto as an established and proven asset class whose long-term upside is the precise reason why it deserves to be stashed away in a retirement account.

“Historically, investors at times have realized meaningful gains on their crypto investments, and have, as a result, paid a lot of taxes,” Sharif-Askary said. “Investors who have conviction around the potential of this asset class, have a more long-term investment horizon, or are looking to make investments in a tax-advantaged manner have turned to crypto investing through a retirement account as a strong solution.”

GO WISELY AND SLOWLY (ROMEO AND JULIET)

Now that regulators have essentially cleared the way for crypto in certain forms to be added to retirement accounts, financial advisers and their clients need to decide which type to purchase and how much to allocate to a portfolio.

Of course, that comes down to an individual’s risk tolerance and time horizon.

For example, Melanie Jones, senior vice president at Evoke Advisors, recommends owning the underlying currency in a low-cost retirement account because “they are tax-efficient vehicles with generally longer time horizons and liquidity needs.”

“It’s important to note that this asset class is still quite speculative, and investors should have a high risk tolerance with a willingness to accept a complete loss of an investment in crypto,” Jones said.

Cynthia A. Pulver and J. David Jensen, co-founders of DJCAP at Kingswood US, utilize a mutual fund structure because their clients are much more familiar with 40 Act funds than cryptocurrencies. The pair say this method of ownership also eliminates custody and key issues by not requiring a wallet on an exchange. Their actively managed fund of choice is the IDX Advisors Risk-Managed Bitcoin Strategy Fund (BTIDX).

“The amount that should be allocated would be on a case-by-case basis on risk tolerance and time horizon,” Pulver said “We may allocate a small percentage in a balanced account for alpha, generally we would allocate for growth and aggressive growth accounts.”

Ronnie Cox, vice president of investments at Pensionmark, is anything but a staunch advocate of putting crypto-assets directly in retirement plans as a result of their volatility and rising correlation to equities. However, for speculative clients undeterred by these risks, he suggests allocations should be limited to no more than 5% of portfolios, and the vehicle should be as diversified as possible.

“My view is that participants would be best suited to invest in a well-diversified fund that is actively managed by experts in the space,” Cox said. “To take it further, I believe that exposure should come in the form of exposure to underlying crypto-assets, and through exposure to companies in the crypto industry.”

Grayscale’s Sharif-Askary feels strongly that crypto exchange-traded funds would be the best option for retirement accounts, but ETFs for pure or spot crypto asset exposure are still waiting for regulatory approval in the United States, having been rejected by the SEC in June. Grayscale is still pushing to turn its Bitcoin Trust (GBTC) into a spot bitcoin ETF. In the meantime, Sharif-Askary said investors seeking to add crypto to their IRAs have several of the firm’s structured products from which to choose.

“Historically, investors have started to build their portfolio with some of the oldest and largest crypto tokens by market cap — bitcoin and Ethereum. With that core exposure, we’ve seen investors build portfolios based on thematic investing, whereby they identify sub-themes in the crypto ecosystem that resonate with their investment philosophy and build a portfolio accordingly,” Sharif-Askary said. “Some of the popular sub-themes that have gained traction are smart contract platforms, DeFi, market-weighted large cap funds and metaverse themes.”