The easiest way to get exposure to bitcoin and its cohorts would likely be to purchase shares in a digital currency related fund. This is also likely to be the only method supported by plans managed by large institutional trustees, such as Fidelity or Vanguard. Digital currency funds essentially operate like money market funds, tracking the price of one or more digital currencies by way of an index (the Winkdex is one such example). You can read a detailed description of the Winklevoss Fund’s proposed method of operation in their latest SEC filing here. Another example (limited to accredited investors) would be the Bitcoin Investment Trust.
If you own a self-directed IRA (also commonly known as a “checkbook IRA”), then another way to get exposure to digital currencies is to invest in one of the many promising start-up companies in the space. Investing in private placements of the securities of early stage companies carries considerable risk, but also the potential for outsized returns. Be advised that you may be required to provide documentation confirming that you are an accredited investor. Also, you should be aware that the IRS does not allow “self-dealing” with retirement funds. In other words, you cannot invest in your own start-up using tax deferred retirement funds that are owned by you (sorry).
Another way to get bitcoins into your portfolio would be to invest directly in them. This course of action is likely to be the most difficult to properly accomplish and require the most scrupulous compliance with IRS rules. For the purpose of IRA investing, the IRA is the investor, not the beneficiary. This means, for example, that an account with an exchange must be titled to the IRA in order to receive tax deferred treatment. A word of caution: active trading in digital currencies by a tax deferred retirement account may result in all or part of the proceeds being deemed “unrelated business income,” subject to income tax.
Companies such as Ravenbit, Titan, and formerly, Casascius, sell metal coins commonly referred to as “physical bitcoin.” The coins, which are often rendered of precious or semi-precious metals, usually have value both as physical objects and as tokens granting access to a particular quantity of digital currency stored on the blockchain. IRS rules limit the types of investments that can be held in tax deferred retirement vehicles, such as IRAs. Collectibles and precious metals are specifically prohibited as IRA investments, but may still be allowed under certain circumstances.
A recent Private Letter Ruling described how collectibles might be allowed as an IRA investment. For the case in question, the IRS determined that membership in a grantor trust by an exempt IRA would not be disallowed as a prohibited investment based solely on the fact that the trust was invested in gold (a prohibited investment). This means that a similar trust invested in physical bitcoins may receive similar treatment. Note that a private letter ruling is not authoritative and cannot be used to avoid penalties by persons other than the taxpayer who requested it. However, they do provide an indication as to how the IRS might rule under similar circumstances. If you think this might be a good strategy for you, be sure to consult a qualified professional.
Digital currencies may be a great way to bring diversity into a self-directed retirement portfolio. Potential investors should be aware of the many restrictions and other pitfalls and plan accordingly.