Investment giant Fidelity recently announced that it will allow participants in its 401(k) plans to invest up to 20% of their savings in Bitcoin, if the employer wants to offer that option.
This shocks me, well, kind of nutty. Even stranger, if cryptocurrencies are your thing, then 401(k)s and IRAs might be the place to do this kind of speculation.
It is a digital currency, which is part of a wider world of similar products known as cryptocurrencies due to the way they are created and verified using computers. Cryptocurrencies are not backed by company profits, or by commodities like gold, or by a central bank promise to pay. Instead, they are created via a computer process known as blockchain and derive value based on the willingness of others to accept these coins as a form of payment.
Cryptocurrencies have uses, if exchange in anonymous transactions is something that is important to you. But cryptocurrency trading is also a subculture in itself, with fans (and girls) who see Bitcoin and its derivatives as a way of life, not just a medium of exchange. As comedian J.B. Sears said, “Being a Bitcoin advocate is like the veganism of the biz. You’ll find out where I stand on this issue within 11 seconds of my interview.” This doesn’t seem like the right mindset for retirement planning.
The logical argument for cryptocurrencies in retirement portfolios is that their returns are not closely related to those of stocks and bonds. Therefore, crypto with other investments can produce a portfolio with higher returns and/or lower risks.
On the other hand, the reason why cryptocurrency returns do not vary in line with other investments is that it is not entirely clear what a cryptocurrency should be worth, and therefore its values fluctuate greatly along with the sentiments of buyers and sellers.
Yes, bitcoin has produced high rates of return in its short history, but it is difficult to recommend cryptocurrencies to savers for long-term retirement when there is no clear reason for their high returns, i.e. more than 17th century Dutch savers should have hoped for tulip bulbs. Bitcoin returns are not driven by its dividend, as with normal investing, but by net increased demand for Bitcoin.
Besides the recent high returns, so has Bitcoin Much More dangerous than the S&P 500 SPX,
Or even alternative investments like private equity or hedge funds. Since 2013, the standard deviation of monthly returns on bitcoin – a measure of investment risk – has been six times higher than the S&P 500. That’s fine for purely speculative investments, if that’s your thing. But it is simply not clear why a well-thought-out retirement saver would want to risk so much with his nest egg.
But here’s the amazing thing: if you intend to speculate in cryptocurrency, your 401(k) might be the best place to do so, thanks to the federal tax policy. The average investor in a risky asset like cryptocurrency is likely to generate a large amount of unrealized capital gains and losses as their investments go up and down.
Outside of retirement accounts, capital gains are taxed, once achieved through a sale, and there is an annual limit of $3,000 for the amount of capital losses that can be deducted from an individual’s taxes.
But America’s major retirement accounts — standalone retirement accounts, 401(k)s and their Roth alternatives — have a tax preference that effectively exempts them from capital gains taxes. With regular 401(k)s and IRAs, you pay no taxes on contributions but subsequent withdrawals are taxed at your income tax rate; With Roth accounts, contributions are taxable but withdrawals are tax-deductible.
In either case, accruals in accounts are not subject to capital gains taxes. You can buy and sell to your heart’s content and not pay any taxes until you withdraw your retirement account.
None of this is what policymakers set out to do for savers after retirement, and fortunately most Americans stick to a buy-and-hold strategy. But ironically, a retirement account is the best place to do something that retired savers probably shouldn’t be doing in the first place.
With America’s retirement system improving further despite legislation such as the SECURE Act and its sequel, recently passed by the US House of Representatives, lawmakers and regulators may want to consider whether cryptocurrency and other highly speculative investments make sense in retirement accounts. The taxpayer is the support Americans in old age will rely on.
Andrew J. Bigs is a Senior Fellow at the American Enterprise Institute.
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