What’s an IRA?
IRA stands for "individual retirement account." It’s a federally recognized investment portfolio for individuals or small business owners who are saving for retirement. It was first introduced after U.S. lawmakers passed the Retirement Income Security Act of 1974. This initial law legalized the "traditional IRA," but multiple advancements have resulted in various types of IRAs, providing U.S. citizens the flexibility to choose. Each IRA policy has unique stipulations that affect tax benefits and maximum contributions.
The purpose of IRAs is to encourage Americans to consistently set money aside for their retirement. For this reason, most IRA plans charge steep fines to anyone who withdraws their money six months before turning 60. IRAs also often have generous tax incentives to encourage people to contribute to their retirement investments.
Currently, most IRAs allow you to invest in the following asset classes:
- Stocks
- Bonds
- ETFs
- Mutual funds
A key difference between an IRA and a stock portfolio is that an IRA has an annual limit on how much you can invest. Also, IRAs don't provide access to more advanced trading features like futures, options, or leverage trading.
Unlike a retail stock portfolio, IRAs often have tax deductions. In contrast, if you open a private stock trading account, you must pay capital gains taxes yearly. You can open an IRA at traditional financial institutions like banks and brokerage houses. Many regulated online brokerage sites offer IRA services.
Common types of IRAs
In the 1970s, Americans only had the option of opening a traditional IRA account. Since then, there have been many "non-traditional" IRAs to choose from, each of which has a unique set of requirements. Carefully review each IRA type to determine which works best for your investment strategy.
Traditional IRAs
Traditional IRAs are best for individuals and couples who prioritize tax deductions on yearly contributions. These retirement accounts will allow you to invest up to $6,000 annually (or $7,000 after you turn 50) and enjoy tax breaks until you start withdrawing. Your tax deductions depend on your income and whether you filed for an IRA with or without a partner.
Remember that you’ll pay income tax to the IRS on whatever you pull from your IRA during retirement. While you don't need to start taking money out six months before turning 60, you should take a "minimum distribution rate" (MDR) from a traditional IRA once you turn 72.
Roth IRA
A Roth IRA involves paying taxes on money that’s going into your account, although all future withdrawals are tax-free. The best way to distinguish between Roth IRAs and traditional IRAs is to focus on the withdrawal fees. You don't have to pay income tax when you start withdrawing distributions from your Roth brokerage account. However, you won't enjoy tax deductions on your yearly contributions while investing in your Roth IRA.
If you’re wondering why you should choose a Roth IRA over a traditional IRA, that’s because the former facilitates tax savings during retirement rather than before.
Another significant difference between Roth and traditional IRAs is that the former has no MDR. If you want, you don't have to pull any money from your Roth IRA. However, the beneficiary of your Roth IRA must start withdrawing the MDR from this fund once it transfers to their possession.
Like traditional IRAs, Roth IRAs are available for individuals and couples. You can only contribute $6,000 yearly (or $7,000 when you turn 50).
SEP IRAs
A Simplified Employee Pension (SEP) plan is an IRA designed for people who are self-employed or small business owners. In many ways, SEP IRAs are the same as traditional IRAs, but they have higher contribution amounts.
As of 2022, you could contribute up to 25% of your annual income or $61,000 to a SEP IRA. However, if 25% of your yearly income is more than $61,000, you can't exceed the $61,000 limit.
Small business owners can also set up SEP IRAs for their employees and contribute to their accounts. All your contributions to a SEP IRA plan are tax deductible, but you must pay income tax once you start withdrawing during retirement.
Like traditional IRAs, SEP IRAs have an MDR once you reach 72.
SIMPLE IRAs
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is similar to the SEP IRA, but it gives employees more control over their retirement savings. As of 2022, employees who have a SIMPLE IRA could choose to contribute up to $14,000 of their salary each year to this retirement plan.
Like traditional and SEP IRAs, SIMPLE IRAs charge income tax when you start withdrawing money. However, as you contribute to your SIMPLE IRA, you’ll be eligible for tax deductions. Also, SIMPLE IRAs have an MDR when you turn 72.
SIMPLE IRAs are available to both self-employed and small businesses, but they tend to be a better strategy for the latter.
What’s a cryptocurrency IRA?
All the above-listed IRAs focus on investments in the bond or stock markets, but an emerging class of "alternative IRAs" offers people access to non-traditional assets like cryptocurrencies.
These "crypto IRAs" often fall into a category called "self-directed IRAs." This category provides access to many non-traditional asset classes, including digital assets, precious metals, and even fine art. You can open a self-directed IRA at a brokerage house as you would a traditional or Roth IRA. You can usually roll over a pre-existing IRA into a self-directed IRA platform.
Although not all self-directed IRAs offer crypto trading, it's becoming more common to find online brokerage platforms that provide access to digital assets. In most cases, if a self-directed IRA offers crypto investing, the brokerage firm will take custody of the invested tokens.
Benefits of a crypto IRA
If you already believe in the future of blockchain, adding digital currency to an IRA may be a good idea. Here are a few potential benefits associated with a crypto IRA:
- Reduced yearly crypto taxes: Filing annual taxes for crypto is complex and potentially costly. However, using an IRA to invest in crypto can help save money during tax season. Crypto IRAs offer a simple way to invest in coins without worrying about calculating yearly gains and losses.
- No need to learn about private keys or storing crypto: You don't need to be tech-savvy to invest in crypto with an IRA brokerage account. In most cases, IRA brokers who offer crypto trading work with respected crypto custodians to safeguard tokens. Companies like BitGo and Coinbase Custody often hold the private keys to coins, so you don't have to secure your crypto on a software wallet or cold storage device.
- Diversification and price volatility: Crypto offers exposure to many tech trends that aren't available on the stock market. If you're bullish on blockchain innovations like the metaverse, play-to-earn games, or DeFi (decentralized finance), you can use a crypto IRA to diversify your portfolio. Also, crypto's price volatility is more extreme than traditional markets, which might lead to more substantial gains in the long term.
- Highly regulated and often insured: Self-directed IRA platforms must undergo rigorous screenings to offer financial services to clients. Many crypto IRA brokers also work with respected crypto exchanges and custodians that offer insurance protections in case of a hack.
Drawbacks of a crypto IRA
Although crypto is becoming more popular as a long-term investment, it may not fit everyone's IRA strategy. Here are a few notable downsides to using a crypto IRA:
- Trading fees and maintenance fees: Although you may save on tax deductions, most crypto IRAs charge trading fees or account maintenance fees. Depending on your trading activity, these costs can eat into potential crypto profits.
- Not ideal for conservative investors: Despite crypto's growing prominence in mainstream finance, it's far more speculative than the Dow Jones and the S&P 500. If you can't stomach high-risk investments, adding crypto to an IRA probably isn't the right move.
- Maximum cap on crypto trading: You can't invest as much disposable income as you want into a crypto IRA account. While every IRA has a different threshold, you’ll be limited in how much you can contribute.
- Reliance on a third-party crypto custodian: Some IRAs offer access to private keys (e.g., the Choice app). However, most self-directed IRAs take custody of crypto. This means you'll have to rely on a crypto custodian to protect your Bitcoin and Ethereum (ETH) from hackers. Also, you won't be able to use the crypto in your IRA account in DeFi.
Wrapping up
At Worldcoin, we aim to ensure that anyone interested in investing in cryptocurrencies has equal access to services like crypto IRAs. We intend to put a share of our crypto in the hands of every individual on the planet for free, paving the way for them. We’re also airdropping free digital tokens like DAI to anyone who downloads our app. Subscribe to our blog to learn more about us and the cryptocurrency market.
