On March 11, the US Department of Labor warned employers sponsoring 401(k) retirement plans to “be extremely careful” when dealing with cryptocurrencies and other digital assets, even threatening to pay extra legal attention to retirement plans with significant crypto investments. .
The rationale is familiar to every crypto investor: Aside from the risk of fraud, digital assets are prone to volatility and thus can pose risks to US employees’ retirement savings. On the other hand, we see established players in the pension market taking steps towards crypto. First, retirement investment platform ForUsAll decided last year to implement crypto as an investment option for 401(k) fixed retirement accounts in partnership with Coinbase. Is this the start of a bigger trend?
Why even bother?
Aside from the simplistic statement 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 investments.
The first is diversification of investments. For now, cryptocurrencies, nonfungible tokens (NFTs) and other digital assets are relatively independent of the larger traditional financial market. In some cases, this could make them relatively stable when stocks 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. This is a matter of both profit and time – every time a US investor makes money from the sale of cryptocurrency, they must register it to report to the Internal Revenue Service. Retirement accounts are generally exempt from that charge. As Dale Werts, partner at law firm Lathrop GPM, explained to Coin-Crypto:
“Trading crypto within a qualified plan would be treated like any other asset transaction within a plan, so the same tax breaks would apply. Normally, asset transfers within a plan are not taxed – that’s the whole point of a qualified plan. Profits you accrue can be withheld tax-free until you make a distribution.”
What the Law Says: 401(k)s, the ERISA and IRAs
Since 401(k) investments are subject to the Employee Retirement Income Security Act (ERISA) of 1974, it’s not surprising that digital currencies fall into a legal gray zone when part of a retirement investment portfolio. The ERISA does not specify which asset classes can or cannot be included in a 401(k). In a slightly outdated way it is obligated confidants to “demonstrate the care, skill, prudence and diligence that a prudent person would” in handling retirees’ hard-earned money.
Yet the vast majority of employers prefer not to go against the spirit of the law; therefore, there are currently few opportunities to invest directly in crypto through 401(k) plans. As Christy Bieber, a contributing analyst at investment advisory firm The Motley Fool, noted to Coin-Crypto:
“Those who use a 401(k) to invest for retirement will generally not be able to buy cryptocurrencies when investing for their later years. That’s because 401(k) accounts usually limit you to a small selection of mutual funds or exchange-traded funds.
A common solution for those nevertheless eager to make crypto a part of their retirement funds is 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 several studies, between 49% and 54% of millennials invest in cryptocurrencies or NFTs and/or consider them part of their retirement strategy.
Werts, who incorporates crypto into his own personal retirement investment strategy, said that while the Labor Department highlighted the general risks and challenges of crypto, ERISA is in no way prohibiting digital assets as an investment option in a 401(k) plan. He sees three primary options for those interested in crypto as a retirement asset:
“You can (if available from your employer) use a self-directed 401(k) to invest in alternative investments such as cryptocurrencies. A simple Google search turns up at least one alternative to ForUsAll: BitWage. Many companies are also working on ETFs (such as Vanguard and SkyBridge Capital), although the Securities and Exchange Commission has not yet approved them. There are investment options for Bitcoin futures approved by the Commodity Futures Trading Commission.” “You can invest in a long list of publicly traded companies that own crypto, such as MicroStrategy, Tesla, Coinbase, Block, PayPal, Marathon Digital Holdings, and Nvidia. I did this. Of course these companies have different business objectives, so you have to be ‘on board’ with whatever those objectives are.” I invested in both). This is easy, and they are like unit trusts or money market funds – you buy a ‘unit’ of a trust, which is fully liquid, rather than a fractional interest in a particular cryptocurrency.
From 2% to 5%
Regulatory hurdles aside, the main argument against crypto in retirement plans is still purely economic. Experts generally recommend that crypto make up no more than 5% of a person’s retirement investment portfolio due to the volatility and unclear regulatory outlook in the United States.
Bitcoin (BTC) is the perfect example of this volatility, as the No. 1 currency has lost some 30% of its market value since November 2021, dropping nearly 50% at one point. That doesn’t come close to the conservative dynamics of the S&P 500: the index showed a stable average annual return of 13.6% between 2010 and 2020.
“Five percent may be the right amount for some investors, but it depends on your individual risk tolerance and on your time frame to retire,” Bieber said, pointing out that the risk of losing everything in crypto assets is still a lot. is higher compared to investing in an S&P 500 fund. And the 5% figure is a better fit for younger investors, while older adults who will soon have to draw from their accounts want to keep their crypto allocation at 2% or less. Bieber added:
“Ultimately, because of the high risk cryptocurrencies entail, don’t invest more of your retirement money in them than you can afford to lose. If 5% of your retirement money were put into digital currency, that would mean you end up with a nest that doesn’t provide enough income, then you need to allocate much less of your money – or no money at all – to this riskier investment.”
What’s next?
Could crypto gain widespread adoption among retirement investors, at least on a limited scale? Bieber believes the scenario is possible if cryptocurrencies continue to be widely accepted by institutional investors, which would both boost their spread to the most conservative corners of the financial market and, in a somewhat positive circle, make them less volatile. She noted:
“It is possible that if the SEC regularly allows ETFs or mutual funds to buy cryptocurrencies directly, more funds could be created to spend on this asset class. And some may eventually be offered in 401(k)s. […] If cryptocurrencies continue to be accepted mainstream and many ETFs or mutual funds are offered that offer exposure to them, target date funds and robo-advisors could also begin to include these funds as part of the portfolios they build.
There is no shortage of interest in crypto, but seeing steady demand in the future relies on an easy, accessible infrastructure that would benefit retirement investors. This means the U.S. regulatory community needs to update nearly 50-year-old retirement laws. In this context, the Labor Department’s recent warning is somewhat like a band-aid, telling 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 carries risks, and readers should do their own research when making a decision.