It seems like every day there is news about cryptocurrency, and often lots of it. As these digital assets become more familiar to us, the question arises whether they can be held inside a retirement account¹. We explore the rules for both an individual retirement account (IRA) and a 401(k) plan; however, no opinion is expressed as to the soundness or prudence of such investments.

Individual retirement accounts

Households with IRAs have eight times the median financial assets of households without IRAs, according to the Investment Company Institute. By the end of 2019, there was over $11 trillion in IRA accounts, representing more than 34% of dedicated retirement assets. To answer our cryptocurrency question as it relates to IRAs, however, we need to separate it into two parts:

401(k) plans

As of June 30, 2021, there was over $7.3 trillion in 401(k) plans, according to ICI Research. Thus, such plans constitute the second most widely held form of retirement assets. Can one own cryptocurrency in these plans?

Unlike defined benefit plans, 401(k)s are employer-provided defined contribution plans. As such, they are funded with cash. Thereafter, the employee is entitled to select investments from a menu of employer-approved investment allocations. However, unlike IRAs, there are not express statutory guidance on prohibited assets. Instead, the IRC provides that an investment menu must have at least three investment options, “each of which is diversified and has materially different risk and return characteristics” (IRC §401(a)(35)(D)). Thus, the answer is that cryptocurrency is permitted so long as it meets the diversification requirement.

Employer liability considerations

There are two aspects surrounding potential employer liability for cryptocurrency in 401(k) plans — investment losses and plan design.

• If an employee selects an allocation that declines in value, can the employee sue the employer? The short answer is no; the employer is not a guarantor of investment success. ERISA
  § 404(c) limits fiduciary liability for individual investment decisions when a participant exercises control over the assets in his or her account.
• In contrast, the employer does have a fiduciary duty to prudently select and monitor investment alternatives. ERISA
  § 404(a)(1)(B) requires plan fiduciaries, including employers, to act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” This means that adding an investment allocation to the plan structure (or failing to monitor it) is something for which the employer may be held accountable if doing so (or failing to do so) is found imprudent. Whether a cryptocurrency allocation option is prudent depends on a number of factors, including the other investment choices.

Other concerns

Beyond prudence and the above analysis regarding legality, numerous risks and other factors are worthy of consideration, including but not limited to:

• Cybersecurity (plan sponsors may not have blockchain expertise).
• Fees (such as custodial and exchange) may be higher than some mutual funds and exchange-traded funds.
• Legal uncertainties, such as bankruptcy of an exchange. The Securities and Exchange Commission now requires a disclosure that crypto assets are not insured or guaranteed by any government or government agency and the legal risks in the event of a financial event such as bankruptcy (Staff Accounting Bulletin No. 121, 17 CFR 211). Depending on the exchange’s business structure, there is the potential that bankruptcy might convert “owners” into general unsecured creditors.

Conclusion

So, the ultimate answer as to the legality of cryptocurrency in the two major forms of retirement accounts is clear — one can hold cryptocurrency inside a retirement account. However, what is not answered is whether one should. If you are interested in learning more, please reach out to your Glenmede Relationship Manager.