I’m sitting on $5 million worth of crypto – should I sell to diversify and eat the $1 million tax bill?

The rise of Bitcoin (CRYPTO:BTC) has created more than a few millionaires, many of whom arose from working within the cryptocurrency industry. Others came from Bitcoin’s meteoric rise in value.

I like to tell the story of a friend who bought Bitcoin early when it traded at just a few hundred dollars each. When it hit $700, I told him to sell, but he refused. When it reached $1,500, I again told him to sell, and he again refused. Imagine my chagrin now that it trades for around $87,000.

It shows that for some, cryptocurrencies have been life-changing. This was brought to mind by a recent Redditor’s post on the r/ChubbyFIRE subreddit, a site dedicated to retiring early and being financially independent, without the lavish lifestyle of the rich and famous.

At 40 years old, with a net worth of $9 million, the Redditor stands at a financial crossroads. While he’s seemingly made it financially, over half his wealth — some $5 million — is in Bitcoin. Despite having risen dramatically in value over the years, the crypto remains a volatile asset and introduces significant risk when you’re considering retiring early.

While the Redditor’s long-term holdings have paid off handsomely, the potential for a catastrophic drop remains. Bitcoin, for instance, shed 70% of its value from November 2021 to November 2022, a reminder that crypto could plummet, erasing millions overnight. 

Conversely, his $2 million in tax-advantaged 401(k), IRAs, and high-yield savings accounts, plus another $750,000 he has in diversified Vanguard funds are more stable.

With annual expenses of $120,000, it suggests the Redditor lives a lean lifestyle relative to his wealth, but the crypto concentration demands he make a strategic pivot. There are essentially three paths he can take.

Option 1: Do nothing and ride the crypto wave

Maintaining the status quo by funding his retirement through his crypto gains preserves the upside. Slowly drawing down the asset by selling as needed, avoids immediate tax hits and bets on crypto’s continued growth. 

The risk of a total collapse, though, lingers. Bitcoin is known for experiencing 50% pullbacks in value and a $5 million loss would slash the Redditor’s net worth in half, jeopardizing his early retirement. It was only in December that analysts were expecting Bitcoin to hit $250,000 this year. It might happen yet, but the crypto is down 15% from the $102,000 it hit in February.

This approach suits high risk tolerance but leaves little margin for error.

Option 2: Minimize risk by cashing out and diversifying

Selling all $5 million in crypto now and incurring a $1.2 million long-term capital gains tax (at a 23.8% federal rate), nets him $3.8 million. Reinvesting into the Vanguard Total Stock Market ETF (NYSEARCA:VTI | VTI Price Prediction) or the Vanguard Total International Stock ETF (NYSEARCA:VXUS) through a taxable brokerage spreads risk across equities, bonds, and global markets. 

At a 4% safe withdrawal rate, it provides $152,000 annually to cover expenses with a bit of a buffer. Combined with his tax-advantaged accounts, it’s a $5.8 million safety net that is immune to crypto’s whims. 

The trade-off is that the tax bill stings and growth slows compared to crypto’s peaks. But he’s gaining stability in return, and with two young children, it is ideal for securing a decade of education expenses ahead.

Option 3: Moderate risk through tax-smart diversification

There is a middle path to take, too. He can cash out $600,000 annually to fill the 15% long-term capital gains tax bracket, which spreads the tax hit over several years. At 15%, that’s $90,000 tax per sale, netting $510,000 to pay for living expenses and invest. Repeating this trims the Redditor’s crypto holdings to $2 million in five years, cutting his exposure to 25% of net worth while building a $2.5 million taxable pile. It’s a $4.5 million shift to safer assets, yielding $180,000 at 4%, all while keeping some crypto skin in the game. 

This option balances risk and reward, while also leveraging tax efficiency.

The best path forward

Now I’m not a financial planner or a tax professional (and I did recommend my friend sell his Bitcoin many years ago), but the moderate-risk option stands out as best. 

Fully cashing out sacrifices too much to taxes upfront, while doing nothing gambles a comfortable retirement on crypto’s rollercoaster ride. Selling $600,000 annually diversifies his portfolio gradually, or some $1.8 million over three years, without torching gains. 

By reinvesting in low-cost ETFs for steady 6% to 8% returns, offers an income cushion, as does keeping $65,000 in cash on hand. The Redditor is able to pay off a $30,000 loan he has, while letting his tax-advantaged funds compound. Risk, of course, remains. Bitcoin could tank mid-plan, but a 75% non-crypto net worth by 2028 is a sturdy floor to stand on.