Adding Cryptocurrency as an Investment Option to 401(k) Plans

by: Erin Sak
Verified by: CPA

September 23, 2022

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Recent years have seen cryptocurrencies such as Bitcoin and Ethereum enter the investing mainstream. A November 2021 study conducted by Pew Research Center found that 16% of Americans had invested, traded, or otherwise engaged with cryptocurrencies. By March 2022, that number stood at 21%, per an NBC News poll.

As cryptocurrency grows more popular, there have been calls from its advocates to add cryptocurrency as an investment option to retirement plans, including defined contribution plans offered by employers. 

By far the most common defined contribution plan is the employer-sponsored 401(k) plan. In 2021, there were around 60 million active 401(k) plans with a combined $7.3 trillion in assets. These plans form the backbone of many Americans’ retirement savings and are largely invested in low-cost mutual funds.  

In April 2022, Fidelity, one of the largest record-keepers of 401(k) plans, announced that it would allow plan participants to invest up to 20% of their account balance in Bitcoin, provided their plan sponsor (typically the employer) permits it. 

Ultimately, it’s up to individual employers whether they want to allow their employees to invest in Bitcoin inside their 401(k) plans. That decision isn’t an easy one. Read on to learn about the benefits and risks of permitting employees to invest in cryptocurrencies inside their employer-sponsored retirement plans. 

How Do Defined Contribution Plans Typically Work?

401(k) plans are the most common defined contribution plans. These accounts are typically funded by both employee and employer contributions. Funds in these plans are commonly invested in assets including index funds and target date funds. 

The asset classes that 401(k) plan holders typically invest in have historically produced stable growth with limited levels of volatility. Some plans also allow participants to invest in individual stocks. 

Until now, cryptocurrencies have not been one of those options for participants. Fidelity’s announcement that they would allow participants to invest up to 20% of their 401(k) portfolio in Bitcoin came just one month after the Department of Labor released a Compliance Assistance Release cautioning plan sponsors to “exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu”.

These events put employers in an awkward position. While some employees may be clamoring for cryptocurrency to be added as an investment option, plan sponsors have important fiduciary responsibilities they cannot afford to overlook. 

As fiduciaries of employees’ retirement plans, employers are legally obliged to ensure that the investment options presented to employees are prudent. If these responsibilities are breached and employees suffer losses, employers can be held liable. 

Why Add Cryptocurrency as an Investment Option to 401(k) Plans?

With so many risks inherent in adding cryptocurrencies as investment options in 401(k) plans, it’s natural to ask why employers would even consider doing this in the first place. Besides giving employees more options to invest their retirement contributions how they see fit, the main benefit is the upside potential cryptocurrency investments are perceived to offer. 

If you had invested in Bitcoin in early 2017, when one Bitcoin was valued at around $1,000, your portfolio would have increased some 20 times over based on Bitcoin’s current value, which has been hovering around $20,000 for much of the summer. 

While that represents a phenomenal return, there are major questions about the volatility of cryptocurrency. These questions are particularly salient given Bitcoin was valued as high as $64,000 as recently as December 2021 before dropping precipitously to its current value. 

The Disadvantages of Adding Cryptocurrency as an Investment Option to 401(k) Plans

It’s clear that there are several major risks associated with offering cryptocurrency as an investment option inside employer-sponsored 401(k) plans, many of which we’ve already outlined. One key issue is the level of volatility associated with cryptocurrencies. 

Standard investment options in 401(k) plans tend to be relatively stable and typically appreciate in value gradually over long time horizons. They’re heavily regulated and are backed by tangible businesses. 

For instance, if an employee chooses to invest in mutual funds, they’re investing in a collection of companies that produce billions of dollars in profits each year. Conversely, if they invest in a cryptocurrency, they may have limited understanding. 

An employer has a fiduciary responsibility to its employees and the overarching goal of a 401(k) plan to proceed very carefully before offering such high risk investment options. 

Making an Informed Choice About Adding Cryptocurrency as an Investment Option to 401(k) Plans

For plan administrators tasked with making these decisions, there’s much to consider. The rise of cryptocurrency constitutes an exciting development in the alternative investments space but major questions remain over its suitability as an investment within retirement plans. 

Currently, this question only applies if your 401(k) plans are offered through Fidelity. Other financial services firms are yet to follow suit. 

If you’re reluctant to offer your employees this option, it’s unlikely you’ll be alone. 

Bitcoin is perceived as an extremely volatile investment, and for plan sponsors, it’s most likely the case that the potential downsides of offering cryptocurrency investments as an option inside employee 401(k) plans outweigh the upsides. Of course, this could change in the future, and the momentum could change as more 401(k) record-keepers consider following Fidelity’s lead. 

For now, it’s best to proceed with caution, and to make decisions only when you have fully weighed all of the considerations––both positive and negative.

Smith and Howard: A Trusted Employee Benefit Plan Expert

While we are not in a position to advise employers on appropriate investment options within their 401(k) plan, we can consult with you on your fiduciary duty and how that will impact your investment option decisions.  If you need an advisor you can trust as you navigate complex financial decisions, Smith and Howard is here to help. Our firm has a proven track record advising businesses in numerous industries, from healthcare to professional services

We offer a range of assurance services, including audits of 401(k) plans, defined benefit plans, and more. Our professionals have deep expertise in ERISA and are proud members of several employee benefit plan professional organizations. We have been named one of Atlanta’s 20 Largest Employee Benefits and Compensation Companies by the Atlanta Business Chronicle for the past 10 years.

To learn more about our employee benefit plan assurance services, contact us today.

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