Spoiler alert: If you plan to skip to the bottom of this article to find out whether you should include crypto in your 401(k), you’ll be disappointed. There is no “yes” or “no” answer. What you invest in your qualified retirement plan depends on your individual circumstances and your comfort with being a risk-taker.
But to get started, consider how you would answer the following three questions:
Is crypto available in my employer’s retirement plan?
The title to a Shakespeare play may answer this question: Much Ado About Nothing. The likelihood that your employer will offer crypto-based funds in the near future is low. The primary reason for all the recent interest in this idea is that in April, Fidelity announced it would offer a cryptocurrency option to plan sponsors. In other words, employers using Fidelity funds can (starting later this year) choose to add a cryptocurrency offering in their 401(k) plans. Specifically, if the plan sponsor chooses, plan participants would be allowed to allocate a portion of their assets to Bitcoin through an option on their 401(k) investment menu.
This announcement does not, however, mean many employers will actually include this option as a choice in their investment basket for participants. First, there has been a flurry of class-action lawsuits filed against plan sponsors regarding their 401(k) plans. The typical allegations are excessive fees, inappropriate investment options and self-dealing. Given this challenge, why, an employer might ask, should we compound this risk by including risky assets in the 401(k) lineup? Second, the Department of Labor (DOL) has been very clear they believe crypto assets are not appropriate for most consumers. In an unusual move, the DOL released guidance warning retirement plan fiduciaries to use “extreme care” when considering crypto investment offerings. This guidance will likely have a chilling affect for many 401(k) plan sponsors.
Another consideration is what “investing in crypto” really means. It could be investing in the well-known Bitcoin currency, but there are other cryptocurrencies as well, such as Dogecoin and Ethereum. It could also mean investing in companies involved with the storing, mining or managing of crypto assets. You must really ask what you’re thinking about when seeking out crypto investments and then explore whether your 401(k) plan has any related funds. Because of the newness of this alternative investment, and the risks involved, your choices are likely to be very limited.
What’s my motivation?
Are you interested in having crypto in your 401(k) because of FOMO (“fear of missing out”)? Investing your retirement funds in an asset class because all the cool kids are doing it is generally not a good idea. Even the biggest fans of cryptocurrency agree that these assets involve significant risk. At a minimum, to invest in such plans, you should have a general understanding of how cryptocurrency differs from fiat money and how blockchain compares to central banking. In other words, know what you’re getting into. This is an exciting new development in alternative investments, but it doesn’t follow that everybody needs to sign up or lose out.
Let’s say you do feel comfortable with how this alternative asset works. A next question might be how it would fit in with other investments in your 401(k)? Does the asset have a positive, negative or no correlation with other funds in your portfolio? This question addresses whether crypto might enhance the diversification of your retirement funds. For example, some investors feel that crypto offers a counterbalance to equities. When the stock market drops, Bitcoin may benefit. While this negative correlation may end up being true in the long run, the recent drop in the value of Bitcoin that coincided with the drop in stock prices has raised eyebrows. Crypto is still finding its place in the pantheon of long-term investment options. Before choosing crypto, understand its place in your investment mix as well.
I plan to invest in cryptocurrency. Would it be better to hold it inside or outside my 401(k)?
This is a question where the answer may be a bit more clear. A 401(k) may be a useful asset location for this kind of investing.
The bad rap some assign to cryptocurrency is not so much in the value of this investment as in the handling of this very new concept. First, tax law is still developing concerning crypto. In theory though, every time you use crypto as currency, you potentially have a taxable transaction. Pay for a pizza with Bitcoin that has appreciated, and you’ll have to report your gain. Besides the sheer inconvenience, consumers aren’t assured they will have adequate accounting of their digital coins. Cryptocurrency is a new industry and many of the intermediaries are not good at keeping track of tax basis.
Another handling challenge is storage of your cryptocurrency. The stories are legendary of investors who misplaced their crypto wallets and ended up losing millions into the digital ether.
These kinds of issues largely disappear when holding crypto in a qualified plan. The currency is being held for long-term purposes, is not used for day-to-day transactions, and resides in a tax-deferred account. Further, fiduciary handling and oversight is supplied by the fund provider and plan administrator, and the plan participant receives the legal protections of the Employee Retirement Income Security Act of 1974 (ERISA).
If you’ve done your homework and want to test out owning cryptocurrency, your 401Ik) might be a good place to start.
The bottom line
To answer the question of crypto in your 401(k), first ask yourself if it’s even available (it probably isn’t) and then ask why (versus why not)? Why do you want this asset as part of your qualified plan retirement portfolio? If the answer is because it’s cool, buy an air conditioner instead. But if you’ve researched this alternative investment and see it complimenting your long-term retirement goals, your 401(k) plan may be the right place to make your first foray into the market.
Co-Director, Retirement Income Center, The American College of Financial Services
Steve Parrish, JD, RICP®, CLU®, ChFC®, RHU®, AEP®, is an Adjunct Professor of Advanced Planning and Co-Director of the Retirement Income Center at The American College of Financial Services. His career includes years spent as a financial adviser, attorney and financial service company executive. He focuses on law, estate planning, taxes and financial strategies that can help enable a successful retirement.