Individuals who want to save for retirement often use an individual retirement account. The main advantage of an IRA is that money put into the IRA for retirement is not taxed in that year and not taxed until it is taken out of the IRA when the person is retired. Likewise, money earned by an investment within the IRA is also not taxed until the money is removed from the IRA. It turns out that you can use this vehicle with cryptocurrencies like Bitcoin as well. So, what is a Bitcoin IRA and how does it work?
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Tax Free Accumulation of Crypto Assets
When crypto winter comes to an end and Bitcoin and the rest become viable investment vehicles again, how can you best accumulate the wealth that you want for retirement? A problem with Bitcoin trading is that while you can make a lot of money with accurate market timing you also see much of those profits taken away in taxes. This assumes that you buy when the price dips and sell when it peaks. It does not apply to someone who simply holds their Bitcoin forever. For crypto assets that you have earmarked for retirement a good way to get around taxes every time that you buy and then sell is to put the Bitcoin or other tokens in an IRA. Then the only time you are taxed is when you eventually remove your crypto tokens from your IRA.
Short Term Versus Long Term Capital Gains for Crypto
When you sell your crypto tokens for more than you paid for them you have a capital gain. For tax purposes if you hold the tokens more than a year it is a long term capital gain and if you sell before a year is up you have a short term capital gain. There can be a big difference between the tax rates for these two categories. The rate at which a long term gain is taxed ranges from 0% to 20% while the rate for a short term gain ranges from 10% to 37% at current rates. In general, people with more income and who pay in higher tax brackets pay more in taxes when they have short term capital gains instead of long term capital gains. The nice part about an IRA is that one typically removes the money when they are retired and have no steady income, so their tax rates are lower. And the person is not taxed on any gain within the IRA for all of the years that they use it to save for retirement.
Exponential Growth for Wealth Accumulation
Long term investors have known for years that keeping money in a paying investment leads to exponential gains. And the greater the yield every year, the greater the exponential growth. If a crypto trader makes 10% a year but pays 37% in taxes they are really only making 6.3% a year. The same money in an IRA earns 10% per year for decades and is only taxed upon removal. With a reliable 10% return year after year an investment will be worth 32 times its original value after 32 years. At 6.3% return per year (our example of appreciation if taxed every year) the investment is 7 times its original value after 32 years. The point is that, assuming steady growth, it is far better to have an investment sheltered from taxes as it grows for years which is what an IRA does.
Making More Money With Crypto Over the Years
There are two basic schools of thought when it comes to buying crypto tokens. One is that crypto is forever and will, with time, outpace currencies like the US dollar and all one needs to do is to hold on for dear life in order to prosper. Anyone who simply buys and holds Bitcoin does not need an IRA. Unfortunately, they may also have purchased their Bitcoin in November of 2021 and have lost two-thirds of their investment by now. The other approach is to trade crypto tokens, try to time the market, and, providing that timing is good, profit with each price swing. These folks need an IRA to avoid having a big chunk of their profits taxed away with every profitable trade.
There are specific rules that apply to crypto trading within an IRA but, in general, one can buy, sell, and move assets from Bitcoin to a money market account and back again. Thus, a successful crypto trader can make money with assets in an IRA account, shelter those gains from taxes, and accumulate greater wealth over the years than if they did not find a way to shelter their gains from taxes.
What Is a Bitcoin IRA? – SlideShare Version