Can you add crypto to a 401(k)?

Cryptocurrency continues to capture headlines and investor attention. With stories of significant gains (and losses), it’s no surprise that some people want to include digital assets like Bitcoin in their retirement plans. Can you really add crypto to your 401(k)? And maybe more importantly, should you?

Let’s break down what’s happening, what’s changed recently, and what it means for retirement savers and tax professionals.

Government changes

A couple of years ago, the Department of Labor made waves when it warned 401(k) plan sponsors to think twice before allowing crypto investments in retirement plans. Their message was clear: digital assets were too volatile and confusing for the average retirement investor. They didn’t outright ban crypto, but they strongly discouraged it.

Fast-forward to today, and the government’s stance has shifted. The Department of Labor has now taken a step back. Instead of warning against crypto, they’ve handed the decision back to plan sponsors, who are responsible for getting it right. In other words, the guardrails are off, but the risks remain.

Crypto with conditions

Just because crypto isn’t off limits anymore doesn’t mean it’s a free-for-all. Plan sponsors must still follow strict rules under ERISA, the federal law governing retirement plans. That means they have to act in the best interest of plan participants and manage investments with care and expertise.

Here’s what that looks like in practice:

• Be prudent. Fiduciaries must act like seasoned professionals, using solid judgment and research before offering crypto as an option.
• Put participants first. Every decision needs to serve the people in the plan—not the sponsor’s personal preferences.
• Diversify. Plans should never become overly dependent on any one type of asset, especially one as unpredictable as cryptocurrency.

Even with the government stepping back, fiduciaries can still be held accountable if things go south.

Crypto in retirement issues

Let’s be honest, crypto isn’t your typical retirement asset. Most people don’t retire on a pile of Ethereum. That’s because digital currencies come with unique challenges that don’t always fit well in a retirement portfolio.

For one, crypto prices swing wildly. One day, it’s up 40%, the next it’s down 20%. That roller coaster ride can wreak havoc on retirement savings, especially for people nearing retirement age who can’t afford to lose money.

Then, there’s the complexity. Not everyone knows how digital wallets, private keys, or blockchain technology work. If plan participants don’t fully understand what they’re investing in, that’s a problem.

Inside a 401(k), any gains from selling cryptocurrencies just like stocks or mutual funds will ultimately be taxed as ordinary income upon withdrawal. This means participants won’t benefit from the preferential long-term capital gains rates that apply in taxable accounts. For investors hoping to capitalize on Crypto’s growth potential, this is a key consideration that’s often overlooked.

Security is another concern. Crypto isn’t stored in a traditional bank or brokerage account. If a wallet gets hacked or a password is lost, that money might be gone for good.

And let’s not forget valuation issues. Unlike a stock or mutual fund, crypto prices can vary across platforms, making it harder to assign a clear value.

All of this adds up to one key point: just because crypto is exciting doesn’t mean it’s appropriate for everyone.

Crypto could show up in a 401(k)

If crypto makes its way into a retirement plan, it will likely be through a self-directed brokerage window. This feature lets participants choose investments outside the core plan menu, like stocks or ETFs, and possibly crypto. Much like stocks sold within your 401k plan, any crypto transactions made inside the plan will remain tax free until any withdrawals are made.

In this setup, the plan sponsor isn’t directly endorsing digital assets. Instead, they’re offering the tools for participants to make their own decisions. That creates some distance and helps the sponsor manage risk.

Some larger plans may eventually include crypto options in their investment lineup, but that would likely come with strict controls, limits, and disclosures.

What’s next?

If you’re a tax professional or plan advisor, be prepared for questions on the recent change regarding crypto. Here’s what to keep in mind as crypto becomes more visible in retirement spaces:

1. Do your homework. Understand the platforms, custodians and specific crypto assets being considered.

2. Avoid adding crypto to default options. Keep digital assets out of target-date funds or automatic enrollment choices.

3. Educate participants. Help them understand the risks, not just the rewards.

4. Consider setting limits. A small percentage (1-5%) might be reasonable for those who want exposure but can’t afford significant losses.

5. Monitor and adjust. Keep reviewing crypto performance and participant behavior to spot red flags early.

6. Keep documentation. Track every step of your decision-making process if questions or lawsuits arise later.

What about taxes?

Crypto inside a 401(k) doesn’t change the tax treatment. It still enjoys tax-deferred growth, just like any other investment. Taxes are due when the money comes out, usually in retirement.

What tax professionals should watch for are the reporting obligations and participant questions. Be prepared to explain how crypto gains and losses are handled inside retirement accounts versus taxable brokerage accounts.

Final thoughts

Crypto is no longer on the government’s naughty list regarding retirement plans. But that doesn’t mean it’s an easy fit. Including digital assets in a 401(k) must be grounded in sound judgment, clear participant education and careful oversight. For now, the best approach may be cautious, giving participants access if they want it, but keeping strong safeguards in place. After all, retirement security isn’t about chasing the next big thing. It’s about getting people to the finish line safely.