Money Girl's Quick and Dirty Tips for a Richer Life

8 Pros and Cons of Investing in Crypto in Your 401(k)

Episode Summary

Before buying bitcoin in your 401(k), understand the benefits and risks.

Episode Notes

Before buying bitcoin in your 401(k), understand the benefits and risks.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.

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Episode Transcription

Hello, friends, and thanks for joining me this week! My name is Laura Adams, and I'm a personal finance expert who's been hosting the Money Girl Podcast since 2008. 

I'm also the author of several books, including my most recent title, a No. 1 Amazon New Release called Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. If you're building a business or want to earn more income on the side, I hope you'll grab a copy of the paperback, ebook, or audiobook today!

My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. I create every show to make sure you come away with practical advice that helps you make better money decisions and takes your financial life to the next level.

Be sure to subscribe to the show and participate by sending me your money questions or comments. You can leave a message 24/7 on our voicemail line at 302-364-0308. You can email me using my contact page at LauraDAdams.com or connect on Instagram at lauradadams.

Today's episode is number 729, called 8 Pros and Cons of Investing in Crypto in Your 401(k).

Fidelity Investments recently announced that it would be the first major retirement plan provider to add cryptocurrency to its 401(k) investment menu later this year. Over 20,000 employers offer a Fidelity retirement plan, and they'll have the option to add crypto, allowing workers to invest up to 20% of their account balance, specifically in bitcoin. If employers choose, they can set a lower bitcoin limit, such as 5%.

While there are thousands of cryptocurrencies in circulation, bitcoin is called the "king of crypto" because it's the oldest and most well-known digital asset. However, if the bitcoin 401(k) gets popular, Fidelity could add so-called altcoins, such as Ethereum, Tether, and Cardano. Plus, other brokerages offering 401(k)s could follow Fidelity's lead and add crypto for their plan participants.

So, just because you might have crypto coming to your 401(k), does that mean you should buy it? That's what I'll help you figure out in this podcast. We'll cover the upsides and downsides of owning bitcoin in your retirement plan at work.

Let's start with four advantages.

Pro number one for investing in crypto in a 401(k) is cutting taxes.

If you're a regular Money Girl podcast listener, you've heard me say that workplace retirement plans are the first place your investment dollars should go. Whether we're talking about buying bitcoin or an index mutual fund, owning it inside a retirement account is brilliant because you get terrific tax advantages.

Let's say you buy $5,000 of bitcoin in your traditional 401(k), and the value explodes to $50,000 by the time you retire. You'd avoid paying capital gains tax on all that investment growth. Instead, you'd pay ordinary income tax on withdrawals from the account in retirement.

If you use a Roth 401(k), you'll get even better results making the same investment. Contributions get taxed upfront with a Roth, so your $45,000 of bitcoin growth would be entirely tax-free in retirement. Once your Roth contributions get taxed, you never pay tax on them again nor on any investment growth in the account, which is pretty sweet.

Plus, unlike a Roth IRA, there isn't an income limit to participate in a Roth at work. So no matter how much you earn, you're eligible to make Roth 401(k) or Roth 403(b) contributions when offered by your employer.

The bottom line is that a dollar in your 401(k) is more valuable than a dollar in a taxable investment account. So, if you believe bitcoin will grow in value over the long term, owning it in a 401(k) (or even in an IRA if you don't have a retirement plan at work) could be an excellent way to defer or avoid taxes on its potential growth.

Since I’m self-employed, I invest for retirement using a SEP-IRA and have a portion of it in crypto. If you want to learn more about crypto IRAs, check out platforms such as Bitcoin IRA and BitIRA. Also, you might want to listen to podcast number 710, called 6 Ways to Invest in Cryptocurrency (Including Tax-Friendly Options).

Pro number two for a crypto 401(k) is simplified tax reporting.

A Finder.com study revealed that more than 23% or almost 60 million Americans owned crypto in 2021. If you're one of them and have had to report crypto gains or losses on your taxes, you know it isn't easy. Crypto tax platforms are trying to simplify it, but we still have a long way to go.

Therefore, an upside to owning bitcoin or any crypto in a tax-deferred or tax-free account is that you avoid the hassle of having to include often-complicated details on your tax return.

The third pro is diversifying your portfolio.

A critical part of successful investing is being diversified or owning a mix of investments that react differently to various market conditions. For instance, if all you own is bitcoin or one tech stock and its value plummets, you're in trouble. But if that investment is a small percentage of your overall portfolio, the loss is negligible. 

Most 401(k)s have investment menus with various index funds, mutual funds, or exchange-traded funds made up of hundreds or thousands of underlying securities, giving you instant diversification. If it's right for you, adding a measured amount of crypto to your portfolio exposes you to digital assets, giving you more diversification. As I mentioned, that’s my strategy, but you need to fully understand crypto’s benefits and risks before jumping in.

Number four is motivating young adults to invest.

Whether you're for or against crypto, there's no denying that it appeals to young people and has motivated them to invest for the future. For many, in addition to being an investment, crypto represents a financial movement empowering the unbanked and liberating citizens of countries with hyperinflation, unstable currencies, and repressive governments. 

Fidelity says they're preparing for the next generation of investors and what they want from their retirement plans. So, perhaps younger investors who haven't been interested in their 401(k)s may take notice when crypto goes on the menu. 

Major financial institutions offering retirement plans provide educational resources and personalized guidance to help participants make informed investment decisions. That could help new investors get education about mainstream investments, such as index funds, allowing them to boost their retirement savings. 

Likewise, if crypto becomes a common 401(k) option, I'd expect that more Americans will learn about digital assets and their current and future role in our global economy. 

Now, let's switch gears and talk about four downsides of investing in a bitcoin 401(k).

Con number one is experiencing volatility. 

You've probably heard that crypto has taken investors on a rollercoaster ride of dizzying highs and disappointing lows. In the final quarter of 2021, bitcoin reached a high near $69,000, but is currently valued at about $30,000 as I'm recording this show.

Fidelity says it wants to "enable employees who are comfortable with the risks and volatility of cryptocurrency to invest in bitcoin." As I mentioned, knowing if bitcoin is right for you is critical before investing in it. For instance, bitcoin’s significant price swings don't make it a good choice for someone averse to risk or with a short horizon and not enough time to ride out a massive downturn.  

The U.S. Department of Labor (DOL) warned 401(k) plan providers to "exercise extreme care" before including crypto on their investment menus. They see the inherent volatility in the crypto market as a risk to participants. Plus, it’s possible that employers could be at risk of getting sued by 401(k) participants who experience significant crypto losses.

The second con for crypto in 401(k)s is not being regulated.

Regulation is controversial because many crypto enthusiasts oppose it. They believe imposing rules could hinder innovation and threaten the decentralized nature of digital currencies. 

Whether you're for or against crypto regulation, consumers must understand that there are no clear policies or consumer protections. Bitcoin isn't backed or insured by the government or any institution. 

Most crypto IRAs use an exchange such as Coinbase or Binance to set up an account in the name of your IRA where your digital assets are kept, and Fidelity will likely do the same. That means your assets are as safe as the exchange your 401(k) provider uses. 

The bottom line is that if your crypto exchange account gets hacked by a cybercriminal, you could lose your digital assets. So be sure that you understand what protections are offered by your 401(k) provider or their crypto exchange before buying bitcoin. 

If you have a negative crypto experience be sure to share it with reputable consumer sites such as the Better Business Bureau, Trust Pilot, and the Digital Asset Advocacy Group. You can visit DigitalAssetAdvocacy.org to find the contact information for your state’s regulatory agency and attorney general.

The third downside is investors not understanding digital assets.

While tens of millions of Americans own crypto, many more are unfamiliar with it or don't understand its underlying technology, benefits, or risks. That could leave consumers vulnerable or encourage FOMO (fear of missing out) crypto purchases following social trends.  

According to the DOL, "Participants are less likely to have sufficient knowledge about these investments, as compared to traditional investments, or to have the technical expertise necessary to make informed decisions about investing in them." 

My recommendation is to never invest in anything you don't understand. So before buying bitcoin in your 401(k), take time to understand its history and underlying blockchain technology. An excellent place to start is Money Girl podcast number 718, called 7 Tips to Avoid Cryptocurrency and NFT Scams.

And finally, con number four is paying higher fees.

Since 401(k)s get managed by a custodian, they charge management fees on top of individual investment transaction fees (such as the purchase or sale of a mutual fund). But when you bring bitcoin into the picture, you pile on more fees for services like security, custody, IRS reporting requirements, and crypto exchange fees that will get passed along to investors.

While you can't avoid fees in your 401(k), my point is not to buy more bitcoin than you should simply because it shows up as an option in your retirement plan. However, if you understand bitcoin and believe it's an excellent investment, buying it in your 401(k) or other retirement account is a smart way to own it.

If you’re on social media, be sure to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.

That's all for now. I'll talk to you next week. Until then, here's to living a richer life!