It is essential to keep the crypto assets of your Self-Directed IRA or Self-Directed Solo 401(k) separate from those of your personal assets.
How do I avoid a prohibited transaction when setting up the cryptocurrency storage for my self-directed account?
In order to properly maintain the Self-Directed IRA or Self-Directed Solo 401(k) Wallet, they must remain in the name of your IRA LLC or Solo 401(k) Trust at all times. This means no co-mingling of your personal or retirement dollars in your accounts or wallets, whether those are fiat (government-issued currency) or cryptocurrency. This also applies to all investor documents, statements, and records.
You can set up a safety deposit box, paid for by your Self-Directed retirement account or a trusted third party to maintain and hold your keys, which will help keep your retirement account "at arm's length from your personal assets.
Violating these guidelines can result in a Prohibited Transaction, breaking the IRS code and resulting in a Disqualification of your retirement account.
What is an example of a prohibited transaction?
An example would be flowing your new IRA LLC dollars into an existing centralized exchange personal account; where you then purchased new cryptocurrency coins which were stored on behalf of the existing personal (non-retirement) account. This would ‘co-mingle’ the personal, taxable assets and the tax-advantaged retirement, which is impermissible.
It is imperative that any provider you work with correctly title the assets in the name of the IRA LLC or your Solo 401(k) Trust.
Can you tell me more about Cryptocurrency wallets and storage?
Storage and custody are important when considering digital assets keys & tokens. There is currently no specific guidance from the IRS on the appropriate measures for crypto & token storage, but the existing guidelines for other eligible retirement investments tell us that an arms-length storage solution is advisable between the account holder and the assets. In 2014 the IRS deemed cryptocurrency as property in a retirement account. Assets such as real estate & precious metals storage precedents currently inform the industry. In which case using a third-party provider or secondary accounting mechanism is recommended. Not only to avoid any prohibited transactions but to insure against loss of property and other potential risks that a single holder can provide.
Ultimately when choosing a wallet function, consider these points:
- Do I plan to hold single currencies or multiple crypto coins?
- Will I be transacting frequently, or holding my positions for longer?
- Am I interested in mobile access, or will home access alone be sufficient?
Common wallet/storage methods
- Exchange: Every exchange will use a varying levels of security, sometimes with one or a mix of the options below. You can speak to your exchange on what their security options are, and if they have assets in an omnibus account or separate account just for your digital assets.
- Desktop: Downloaded and installed on a specific computer, as desktop wallet offers a fairly high level of security. This method risks any damage to the machine, whether physical or digital in the form of a hack.
- Mobile: The wallet runs on a mobile device, typically a phone, and is accessible from any connected location. The storage is generally considered ‘hot’ and exposes the account to third party risk, in the form of exchange and network hacks.
- Online: These run on the cloud, and are accessible from any computing location. Often integrated into a Centralized Exchanges product offering. Though convenient these are not the utmost secure options.
- Paper: This term refers to a print or physical copy of your private and public keys. Exchanging cryptocurrencies through your paper wallet occurs through a software wallet to a public address affiliated with your paper wallet.
- Hardware: Offering one of the most direct and secure functions, your private keys are stored on a hardware device, such as a USB. Generally, the best practice for IRAs is to maintain a copy of these keys with a trusted banking or third-party custody provider.
Definitions to know
- Wallets are a vehicle for storing cryptocurrency. There are many different forms of online and offline wallets covered in the storage options above
- Hot Storage refers to the internet connectivity the wallet has. Though this makes cryptocurrency easy to move, trade, and transact with, it is more exposed and less secure.
- Cold Storage is an offline wallet that refers to the barrier between the asset and any live network. With cold storage, the digital wallet is stored on a device that has limited or completed cut off on a connection to the internet, thereby, it aims to protect the wallet from unauthorized access, cyber hacks, and other vulnerabilities that 'Hot' solutions could be vulnerable to.
- Keys open a wallet, which may have been stored in many different methods. It is crucial to never share your keys online/offline with anyone except a trusted party, and store them in a safe place.
- Centralized Exchange is a crypto trading exchange that helps you exchange US Dollars (fiat) for other dollars. After your fiat dollars are in crypto, you can also usually directly exchange crypto for other coins. The exchange might have proprietary storage or third-party custody options above for increased security. Only deal with trusted exchanges and those that can give you confidence that they can handle your storage needs and those of your Self-Directed IRA or Self Directed Solo-401(k)
What storage method is best for me?
We encourage a thorough discovery and review of the storage solutions before transacting. As we are not cryptography experts or financial advisors, Rocket Dollar defers to our valued partner network for the detailed education and conversation.
Want to read more?
- Why cryptocurrency could have a place in your portfolio. A look into the cryptocurrency options.
- Cryptocurrency with Mark Peck on the Rocket Your Dollar Podcast.
- The Basics of Self-Directed Investing in Cryptocurrency.