How to Invest in Digital Currency with Your IRA

How to Invest in Digital Currency with Your IRA A Do-It-Yourself Step-By-Step Guide to Get You Started

This guide is organized into 6 sections, one for each step of the process:

  1. Overview
  2. Choosing a custodian
  3. Forming an LLC
  4. Opening a bank account
  5. Opening a digital currency exchange account
  6. Purchasing and storing your digital currency

The first three steps in the process are mostly common to any self-directed IRA set up. According to CoinIRA.com the federal tax code outlining IRAs does not limit investments to stocks, funds, etc., rather it prohibits certain transactions (for example, Investing IRA funds in a company owned by the owner of the IRA). Again, there are many more comprehensive source on this subject. The tax code does describe the responsibilities of a “custodian”, a financial services entity which holds the funds on behalf of the IRA owner, and invests them as he or she directs, while keeping the necessary records, etc. Most custodians however only offer a narrow scope of investment option (stocks and mutual funds) – much narrower than required by law. Fortunately, there exist several custodians who are willing to host “self-directed” IRA’s (SDIRA’s). In such an arrangement, a company (typically a Limited Liability Company [LLC]) is created with the IRA custodian as the sole member, and the account holder (you) as the sole, uncompensated manager. You, the manager, must NOT be a member (i.e. not an owner) of the LLC. This the first steps are to create this company and find a custodian to host the SDIRA. Next, accounts need to be created in the name of the LLC at both a traditional bank and a digital currency exchange.

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Once these steps are in place, funds can be transferred: first, from your existing IRA custodian ( or, directly from your personal funds if you are beginning with a new IRA contribution) to the SDIRA custodian ( this need not be total; it is fine, if desired, to leave some funds with a traditional custodian); second, you will need to direct your SDIRA custodian to invest the IRA funds in the LLC you have created, by sending funds from your SDIRA account to the bank account that has been created in the LLC’s name; third, transfer funds from the LLC’s bank account to the digital currency has been purchased on the exchange, most investors feel it is wise to move most of their digital currency to an electronic or physical wallet that is not connected to their digital currency exchange account.

  • Choosing a custodian

First, be aware that there are companies (such as Broad Financial) that take care of everything for a larger fee; this is not needed for such an option! I will assume from this point forward that the reader has chosen to take advantage of the lower cost and greater flexibility than “rolling their own” SDIRA enables. Most custodians publish a full fee schedule on their website. In the custodian’s fee schedule, look for: no partial termination fees, low annual fees, and low wire fees. Partial termination fees may accrue whenever you take any amount of money out of the account, and can quickly add up once you begin to regularly draw distributions from your IRA ( this may be a long way off, but good to think ahead). So be sure to find a custodian that does not charge them.

While you could set up your LLC first, or in parallel with your custodian search, I recommend first finding a custodian who has explicitly agreed not only host your IRA but to invest (at your direction, of course) the funds in the LLC you create. Therefore, sending them the draft operating agreement before the company is actually created assures that the custodian will specifically perform the service you need before you spend any time or money on creating the LLC. My custodian did not request any changes to the LLC structure as originally proposed with the operating agreement included with the book.

  • Creating your Limited Liability Company (LLC)

First, you will need an operating agreement. The operating agreement (OA) establishes the nature of the LLC, its members (owners; in our case, there will be only one) and its management structure. Be advised that if you intend to use your SDIRA for other investments such as private lending or real estate, that you most likely need a more complicated OA. There is, to my knowledge, no “free” boilerplate OA available on the internet that will suffice for this purpose.

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The type of LLC this operating agreement establishes is known as a “sole member, manager-managed” LLC. The most important aspect of this operating agreement (and somewhat uncommon among LLCs generally) is the distinction that the manager IS NOT a member (members are entities owning a stake in the LLC). This is important, since YOU will be the manager, and your SDIRA funds may not be invested in a company in which you possess an ownership stake. The first consideration you need to address informing the LLC is the state in which you will create and register it.

There are advantages in forming the LLC in the state in which you reside, because your home address can be the address of the LLC, and you can open a bank account in the name of the LLC at your local bank.

However, many states have onerous fees or reporting and publication requirements that may drive you to consider other states with lower regulatory burdens. Ideally, your state of registration will have a one-time (as opposed to recurring) fee, no reporting requirements, no taxes, and no publication requirements. (Believe it or not, a few states still require that new companies run notices in local newspapers!).

Additionally, the filing process for the state of choice should ideally be quick and all online. New Mexico and Ohio meet this ideal at the time of writing, with New Mexico being the cheaper option.

If you do decide to form your LLC outside of the state in which you reside, be aware that this will somewhat limit your banking options to banks which have physical operations in both your LLC’s state and your state of residence. For most combinations of states, this is not an insurmountable problem.

Beyond the relatively minor banking complication, forming an LLC outside your home state will require you to enlist a registered agent or virtual office service for as long as the LLC exists, unless you have a friend or relative in the state who will allow the use of their address as the LLC’s physical address. There are many services for this and a simple internet search will reveal many of them. I advise choosing an inexpensive one since you will be paying them every year and using them very little. Once you have chosen the state in which you will create your LLC, you may either go ahead and create it online or complete the operating agreement first. Many states do not require an operating agreement, and most do not require it at the time of creation. Therefore in most cases, I would recommend creating the company first; that way, if you run into any difficulties with your first choice state, you can change your mind without having expended effort yet on the operating agreement. Whether you complete it before or after, the operating agreement will need to be customized with the appropriate state, company name, address, as well as your name and the name of your account at your custodian as the sole member. You will need to sign the agreement with the manager, and an authorized representative of your custodian will need to sign as the LLC’s sole member.

Finally, when you create your company, the secretary of state will issue either a certificate of organization, articles of organization, or both. Make sure to retain these documents. After the LLC has been created, go to the IRS website and register for an EIN (Employer Identification Number). Annoyingly, even though the EIN is created instantly, it will need to be sent to the custodian and not you, so you will need to coordinate with your custodian to receive this document. In general, I will intentionally not include links to websites such as the EIN page for the IRS, since these may change over time and in any event, it is trivial to search for the correct and current page. Another small detail: when creating the company, and at various other points such as creating a bank account or a cryptocurrency exchange account, you may be required to declare what sort of business the LLC is engaged in (such as forestry, railroad construction, etc.). Usually, you will be required to pick this from a list, and every entity seems to have a different, only partially overlapping list, and often none of the options is a good fit. You may often find it impossible to be consistent, or even correct. Avoid stating that the LLC is in the financial services industry, because it is not, and declaring it to be so may invoke onerous and inappropriate regulatory checks. The LLC is created to invest your SDIRA money in digital currency, nothing more, nothing less. Do your best to answer truthfully, but don’t worry too much if none of the list choices is a good match; pick something reasonable and move on. To get you started, please feel free to use the boilerplate operating agreement that follows (copy permission granted to purchasers of this book for this section for the purpose of setting up their own LLC).

  • Creating a Bank Account for your LLC

This is a relatively simple step. If you created the LLC in your home state, you should be able to go to your local bank and simply open an account, provided you have brought along all the business documents you have gathered, along with personal identification. If you have created your LLC in another state, you must seek out a bank with operations in both your home state and the state in which your LLC is registered. This is not actually that difficult as there are several large banks with nationwide service. Three banks that may suffice are Bank of America, Capital One (Spark Business) and SunTrust. You will need to open a business checking account. All of these major banks are competent business entities, though the fees and minimum balances differ somewhat. I recommend applying for accounts at all three at least. As you will see, they all have slightly different verification requirements, different forms, and require different subsets of your business documents. You might think that federal Know Your Customer (KYC) regulations would result in a standardized process between banks, but no! Some banks may verify you more quickly than others, so again it is best to simply apply to them all and see which comes through most efficiently. I found it useful in the next step to have accounts with two different banks because of various compatibility issues.

  • Opening an Account at a Digital Currency Exchange

In this step, you will set up an account with a digital currency exchange in the name of the LLC. In my case, this turned out to be the most difficult step. Most exchanges are set up to service individual investors, however many do offer commercial or corporate accounts as well (remember, you must always keep your investments in the name of the LLC, and never co-mingle SDIRA funds with your other non-IRA investments!) Though the difficulties I experienced were different with each exchange, my overall impression was that none of these exchanges are competently run. However, there are enough of them such that you will almost certainly be ultimately successful with one or more. I made the mistake of reading reviews and applying to the most highly regarded exchanges first. Sadly, a better approach in retrospect is to simply apply to as many exchanges as you can manage. They are all pretty shaky, so cast the net wide!

Be aware that, though you will be setting up the account in the name of the LLC (again, this is absolutely necessary) you will also have to provide all your personal information as well drivers license or passport, possibly proof of residence documentation etc., etc. You must absolutely avoid sending any funds from your IRA to an account in which you personally are the account holder. If you do this, in the best case, your funds will end up in limbo, since it is generally required that the account holder of the originating bank account and the account holder at the receiving digital currency exchange be the same entity. In the worst case, if your IRA funds are ever co-mingled with your personal, non-IRA funds, your IRA may be partially or completely deemed to have been “distributed”, incurring all the taxes and penalties which would accrue if you intentionally withdrew your IRA funds. Another common area of troubles is connecting your bank account to your exchange account, a necessary step in funding your exchange account so you can purchase digital currency. I found it helpful to have accounts with multiple banks because for unknown reasons, sometimes one bank account would not successfully connect to an exchange account.

  • Purchasing and storing your digital currency

Since you’re purchasing, and therefore storage methods will necessarily be dependent on your chosen investment vehicles and strategy, I will address this subject in a broad way, since this book is just a how-to, and not intended in any way as investment advice. If your exchange account does not handle the particular variety of cryptocurrency you would like to purchase, it is usually possible to convert more common types to more esoteric ones using online services. I have found shapeshift.io to be a reliable conversion tool. Once you begin to purchase your digital currency, you need to have a plan for secure storage. The first principle to follow is to not leave large amounts of currency – digital or fiat – in the care of a digital currency exchange. Instead, is if best to transfer your funds in chunks that, if disaster struck, would not individually be financially catastrophic to lose. When you first establish an account at a digital currency exchange, send a small amount-the equivalent of a couple hundred US dollars – to make sure the money ends up in the right place, and that once you have funds in the account, you can use them as you intend (i.e. buy your currency of choice). If you have not ever sent a wire transfer before, make sure you understand what all the fields of information required mean. You’ll need to specify information regarding the recipient (the digital currency exchange) and THEIR bank.

The exchange will supply these to you, but when you log in to your LLC’s bank account to initiate the transfer, the field labels may be subtly different. Importantly, your exchange will generally also specify a number which you must enter in a “description” or “notes” field of the wire. This is so the exchange can credit the wire specifically to your account. Don’t omit this, or you may be essentially sending the money to the exchange’s general funds, not your account there! Finally, it is important that the originating bank account the account in the name of the LLC has the same account holder’s name and address as the digital currency exchange account (both should be the relevant information for the LLC, of course). Once you have confirmed your funding method with a small amount and followed up with a larger amount (your first “chunk”; my chunk size was $5000, but again, choose an amount that would not be suicide-inducing to lose!) you may begin purchasing the digital currency of your choice. Again, I recommend starting with a small amount a couple hundred US dollars’ worth. The ultimate destination for you digital currency should not be the exchange account, and as mainstream a form as possible. My personal choice has been an Electrum wallet, which I access via an installation of Tails, a security-focused Linux distribution which can boot from a USB drive. For less technically inclined investors, the Nano Ledger is another secure option for Bitcoin and some other currencies.

Ideally, you will choose a platform that will be long-lived; a perfectly secure niche wallet implementation that is abandoned by the developers in a few months or years is not where you want to store your coins. Naturally which coins you are buying may limit your choices. However, in nearly all cases, your wallet is associated with a seed from which it can be reconstituted. Never write the seed down in electronic form. Do not take a picture of it with your phone. If you ever get hacked, the thief can take all your coins and you will have no recourse to recover them. Make three copies on three pieces of paper, along with written instructions on how to recover the wallet from the seed (typically, the seed is in the form of several words in a particular order). If you are keeping this investment until you retire, or if your beneficiary needs to access your coins because you got hit by a bus, this will come in handy. Give one piece of paper to your beneficiary, and put another copy in a safe deposit box at your local bank. I highly recommend going through the recovery process while there is only a couple hundred US dollars’ worth of currency in your wallet. This will aid in writing down the recovery steps, as you confirm that everything works as planned.

Finally, whether you are a frequent trader or intending to buy and hold for the long term, it is a good idea to log into your accounts and digital wallets periodically. Interfaces change, software platforms are upgraded, and very likely some exchanges will change hands or even go out of business or cease operations. Being in charge of your own IRA on this fine-grained level, unfortunately, means keeping on top of all that could go wrong for the life of your investments!