- As of 2021, more than half of the crypto positions in the market are owned by investors older than age 45
- If you pass away without assigning a beneficiary of your cryptocurrency, your coins are at risk of dying as well
- Approximately 20% of the outstanding supply of Bitcoin, or $140 billion, appears to be in stranded wallets due to lost private keys (passwords)
- The Biden administration’s proposed American Families Plan will repeal the step-up in basis on transferred assets and the favorable long-term capital gains rate, imposing an effective tax rate of 61% on high-value estates
Why do we work so hard? Some would argue that we sacrifice our blood, sweat, and tears to ensure our family will be protected after we are gone. Sure, saving to retire comfortably is crucial. However, most parents also want to help empower their kids and grandkids to achieve their financial goals. Estate planning is necessary for anyone who wants to secure wealth for their family.
Planning for anything can be challenging in today’s rapidly changing market, especially for those who own cryptocurrencies. (My colleague Michael Ashley Schulman, Running Point’s chief investment officer, covered the pros and cons of crypto investments in his piece “Bitcoin—No Heads, No Tails“.) It is well established that the dangers inherent with these investments can leave your estate vulnerable to threats from hackers, lost passwords, or your executor’s lack of proper instructions or authority to access your crypto wallets. This post will attempt to assuage any anxieties you have about passing your cryptocurrencies through your estate, and highlight risks that others faced in the past so you can prepare accordingly.
Disclaimer: This post is for informational purposes only and should not be construed as tax, legal, or investment advice. The area of cryptocurrency taxation is constantly evolving and is not black and white. Consult your own tax expert, CPA, or attorney on how you should treat taxation of digital currencies.
Many investors have the viewpoint that cryptocurrency is primarily the millennial generation’s game. After all, they generally understand technology better and have the risk appetite to take on volatile investments. This was the reality for the first several years after cryptocurrencies hit the market, but this trend is constantly evolving. As of 2021, it is estimated that more than half of the crypto positions in the market are owned by investors older than 45.1 You may be thinking that 45 years old is too early to start planning for your estate, but if anything is to be learned from the events of 2020, it is that life changes when least expected. Do you want your assets to get stranded or go to probate court after you die rather than to your loved ones? Of course not.
All major estate planning decisions are based on maximizing the wealth that will be transferred to your descendants or charities of choice. When applying this to the scope of passing on your cryptocurrency assets, consider incorporating these three primary steps into your planning decisions:
A. Choose whom to pass on your cryptocurrencies
B. Decide how to securely store the information
C. Determine the level of access your executor will have to your cryptocurrency assets
Choose who will inherit your coins
It is essential to have a plan drafted for how you want your assets distributed to your heirs through a written will. That way any disagreements among your loved ones are minimal. Equally important is to draft up a how-to guide for how your crypto assets may be retrieved by your fiduciary. One difference between cryptocurrency and nearly all other types of financial accounts is that cryptocurrency does not have a beneficiary designation attached to it (unless managed through a portfolio manager such as Running Point Capital Advisors). Because of this, if you die without assigning a beneficiary and providing proper instructions to your fiduciary, your cryptocurrency is at risk of dying as well. Be sure to have a conversation with your heirs while you can, as they need to be knowledgeable on all aspects of owning, managing, and maintaining crypto investments. Afterall, they should reap the benefits you bestowed them, not “bitcoin bandits.”
Decide how to securely store the information
Once a unit of cryptocurrency is purchased, it is held within a digital “wallet,” which is a secured medium for holding digital assets with a reduced threat from hackers. Various types of wallets offer differing levels of security, but they generally fall into one of two categories: hot storage and cold storage.2
Hot Storage: entirely online with immediate access. They are generally considered more user-friendly and accessible, but come with an elevated security risk from hackers. They are convenient and make owning cryptocurrency a possibility for a wide range of people of different ages and technological literacy.
Cold Storage: stored on a physical platform that can be plugged into a computer, keeping the cryptocurrency completely offline. The account is synced to the crypto exchange’s internet server only when a trade is anticipated and executed. Although this option requires more technical prowess from the user, it tends to provide the highest level of security.
All digital wallets make use of a public/private key security system, which is a two-key authentication technique for sending encrypted messages over a network to initiate a trade. Any person can encrypt a message using the intended public key (think username), but that encrypted message can only be decrypted with the private key (think password).
Your wallet is effectively useless without custody of both keys. Thus, it is essential to provide instructions to your fiduciary before you pass away. However, extreme care must be given when evaluating how these numbers are stored. If the information is lost, damaged, or stolen, your coins will be gone forever.
Can you imagine losing a significant portion of your estate due to a lost password? It happened to Matthew Mellon, a banker who died unexpectedly at the age of 54 and did not leave his private keys with his family. His account would be worth over a billion dollars today, but unfortunately his family may end up with $0.3 They are not alone; sadly, approximately 20% of the outstanding supply of Bitcoin, $140 billion, “appears to be in lost or otherwise stranded wallets.” 4
There are several ways to safely store your keys, with various tradeoffs. When making this decision, consider exposure to hackers, exposure to unscrupulous family members, and the potential for the keys to be lost or damaged. Whatever you do, don’t just leave them on a sticky note!
Ensure your fiduciary has access to your digital assets
Many states have adopted their version of the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA), which allows a person drafting their will to permit their executor, administrator, or other fiduciary authority over their digital assets upon their death.5 The access they will have to your digital assets depends on the authority granted through your will, but may include up to full or partial access sufficient for them to perform their duties.
In California, many estate plans are drafted with a short, abbreviated “pour–over” will that says anything that is covered by the will, but not in their revocable trust (if one is already established) should only be transferred to the trust and distributed according to the trust’s terms. Persons adopting this strategy should consult their attorneys to ensure the language contained in the will establishes sufficient rights for the digital assets to be contributed into your trust and your trustee the ability to access the digital assets so they may be distributed according to your estate plan. If the language within the will is not legally adequate to grant rights to your digital assets, no one else will be able to distribute them—not even the government.
Alternatively, the more appropriate strategy should be for each digital asset to be titled in the name of your trust, so your heirs have the proper identity of your digital assets, and the assets are properly administered under the terms of your trust. Also, if the digital assets are owned by the trust, then the trustee has the authority to manage the digital assets under the terms of the trust.
Tracking your investments
For tax purposes, the IRS has taken the position that cryptocurrencies are property rather than currency.6 This means that upon sale of the property, the associated gain on the coin—that is, the difference between the price you paid, and the cash received (by your heir) once sold—is the recognized gain. When property is transferred through an estate, the holding period (short-term versus long-term) will also transfer to your family members. Therefore, always track when you purchased a coin and for how much. Like a sale of stock, if you have held on to the coin for longer than one year, the gain is considered long-term and qualifies for a favorable long-term rate.7 If the currency was held for less than a year by both you and your heir when sold, the gain will be considered short-term and taxed at your heir’s marginal tax rate.
Even more beneficial is the step-up in basis to fair market value on the assets that pass through the estate process. This was created so that inherited assets are not taxed twice by the estate tax and capital gains tax. Suppose you bought a Bitcoin in 2010 for 8 cents. You could leave this coin to your heirs, and once they receive it, their basis in the coin will be stepped up to fair market value on that day. This allows your loved ones to sell the assets right after they inherit them and pay virtually no tax. Alternatively, suppose the coin’s value increased by $5,000 a month after inherited, and your heirs decide to sell it then. They will only be taxed on the $5,000 appreciation while under their control, and still at the favorable long-term rate.
Nothing is certain except death and taxes, but how those taxes are calculated are endlessly contested. The Biden administration’s proposed American Families Plan is a looming threat to the current step-up provisions. If passed as proposed, the unrealized gains associated with any asset transferred at death would be subject to estate tax. Furthermore, this act will repeal the favorable long-term capital gains rate for taxpayers with income greater than $1 million, forcing the estate to be taxed at ordinary rates.8 The combination of these two changes creates a double taxation at an effective tax rate of 61%.9 If these provisions are passed, it could create extreme limitations on your family’s ability to maintain the wealth you have secured for them over your life. However, hope is not lost if these provisions are passed. Our team of professionals here at Running Point have a variety of alternative strategies that may be tailored to your situation and implemented to protect your multigenerational asset transfers.
Constant evaluation of the plan
As always, changes give rise to new opportunities. That is why proactive estate planning is so imperative. However, your estate plan will change as your life changes. One look at how cryptocurrencies have changed the economic landscape in the last 10 years makes it is clear that continual evaluation of your plan is critical. Staying ahead of potential fluctuations in the market and tax legislation will expand your opportunities and prepare you and your heirs for the next stages of life.
At Running Point, our clients benefit from an experienced multidisciplinary group of professionals. We help our clients through gaining a clear understanding of your values, goals, and objectives. Then we work together to develop comprehensive strategies to help you implement these objectives to your financial or estate plan. That way when the time comes, you can rest easy knowing that your family and your assets are secure.
Todd Stern, CPA
1 “The Future of Money: Cryptocurrency Adoption in 2021.”” 2021: The Year of Crypto?, Stellar, Wirex, 21 Dec. 2020, The Future of Money: Cryptocurrency Adoption in 2021.
2 Bauer, Roderick. “What’s the Diff: Hot and Cold Data Storage.” Backblaze Blog | Cloud Storage & Cloud Backup, 7 Feb. 2019, www.backblaze.com/blog/whats-the-diff-hot-and-cold-data-storage/.
3 Cavicchioli, Marco. “The Matthew Mellon Ripple Treasure Disappeared into Thin Air.” The Cryptonomist, 30 May 2018, en.cryptonomist.ch/2018/05/30/matthew-mellon-ripple/.
4 NY Times, Lost Passwords Lock Millionaires Out of Their Bitcoin Fortunes, 1/14/2021, https://www.nytimes.com/2021/01/12/technology/bitcoin-passwords-wallets-fortunes.html
5 Calif. Prob. Code §§ 870 et seq. -Revised Uniform Fiduciary Access to Digital Assets Act
6 IRS Notice 2014-21
7 15% for most taxpayers
8 General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposal. United States Department of the Treasury, May 2021, home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf.
9 Hodge, Scott A., and Garrett Watson. “Joe Biden’s 61 Percent Tax on Wealth.” Tax Foundation, Tax Foundation, 29 Apr. 2021, taxfoundation.org/joe-biden-estate-tax-wealth-tax/.
Disclosure: The opinions expressed are those of Running Point Capital Advisors, LLC (Running Point) and are subject to change without notice. This is not an offer to buy or sell or a security or a recommendation to buy or sell a security. Forward looking statements cannot be guaranteed. Running Point is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Running Point’s investment advisory services and fees can be found in its Form ADV Part 2, which is available upon request. RP-21-15