Here’s What Can Happen to Crypto When You Die—and Why You Need To Plan Ahead

Cryptocurrency investors go to great lengths to safeguard their holdings. Crypto enthusiasts commonly employ hot and cold wallets, trusted crypto exchange platforms, and complex cryptographic keys to protect digital assets from theft and other dangers. But what happens to those crypto holdings when their owner passes away?

If an individual holding cryptocurrencies dies without a will and without providing instructions on accessing those holdings, the short—and unfortunate—answer is that they are lost forever. By some estimates, about 20% of all Bitcoin tokens are lost and unrecoverable.

If you are a crypto investor, it’s essential to take steps now to guarantee that any of your digital holdings can be safely transferred to your heirs.

Cryptocurrency as a Digital Asset

In the U.S., cryptocurrencies are considered by the IRS to be digital assets, and more specifically, convertible virtual currencies—that is, the government treats crypto tokens as property rather than as currency. This has a variety of tax implications and also impacts the way that cryptocurrencies are treated in issues involving inheritance and transfer of ownership.

Given their status as digital assets, the U.S. government views cryptocurrency tokens in a manner more similar to stocks or to tangible property like artworks and jewelry than to cash. This means that crypto holdings are potentially subject to capital gains tax.

Essential to planning the transferral of ownership of crypto holdings is understanding the use of wallets. These applications help secure digital assets and facilitate transactions between crypto investors. They are typically secured using both an address or a public key (a way in which the wallet can be publicly identified so that other wallets can transfer in tokens, for example) and a private key (a secure password usually available only to the holder of the wallet).

In many cases, wallets are provided by crypto custodians, such as digital asset exchanges, and can be accessed through their interfaces. Otherwise, one can access non-custodial wallets using the private key or a mnemonic seed phrase.

Cryptocurrency Challenges in Estate Planning

Because cryptocurrency is not treated like traditional money by the IRS, it makes the process of estate planning and inheritance involving digital tokens more complex. Because the government views crypto as personal property, you may need to specifically name a beneficiary in order to inherit cryptocurrency investments.

Crypto may also be subject to different estate and transfer taxes. When the beneficiaries of your crypto holdings use those tokens as a payment method or go to exchange them for fiat currency, it will likely trigger a tax event, and they will need to calculate capital gains or losses, for example. If you give crypto as a gift, it won’t be recognized as income until it’s sold or exchanged.

How To Ensure Your Beneficiaries Inherit Your Cryptocurrency

While a will and a detailed, written plan for transferral of ownership of digital assets is extremely helpful for your next of kin, it’s crucial to remember that this is not enough. While a will may make it legally clear that, say, your children own your crypto holdings, this is no guarantee in and of itself that they will be able to access and use those holdings.

Chris and Charles Brooks, the CEO and CTO of CryptoAssetRecovery.com, explained that there are several other steps investors should take to facilitate a smooth and complete transfer of cryptocurrency ownership. These steps include:

1. Inform Your Heirs

“Make sure that your loved ones—or at least your lawyers—know that you have crypto.” The father-and-son team that runs the digital asset recovery service suggested that communication is an essential first step, as beneficiaries will be helpless without knowing that you have crypto holdings and in which wallets they are stored.

2. Document (and Secure!) Backup

“Record seed phrases or other forms of backup, store them safely, and share with people you trust.” Documenting the ways to access your wallets is essential as well. However, keep in mind that anyone with this information can access these tokens, so it’s vital to keep the documentation secure.

3. Test Your Recovery Seeds

While you still have access to your digital wallets, test the recovery seeds to ensure that they will work for your next of kin and that they are linked to the appropriate wallet containing the assets you wish to transfer.

4. Build in Redundancy

“Consider upgrading your plans using secret sharing and/or multi-signature techniques to share partial backups with multiple people.” Building redundancy into your cryptocurrency management practices will help to protect them against theft during the process of transfer to a beneficiary.

5. Consider Using a Custodial Service

The Brookses said that, while some crypto investors shy away from custodial services due to the history of hacks targeting these companies, “the benefits are that these custodians have extremely robust security practices and existing systems for transferring assets to your estate after death.” When working with a custodian, the beneficiaries should be prepared to provide documentation including a copy of your will, probate documents, and proof of identification.

6. Don’t Count on Current Technology

The Brookses suggested that crypto investors avoid using mobile phones as a backup method, as the phone you utilize may be dead or the wallet app you use may be non-functional by the time a transfer is needed. Similarly, some of the most popular crypto wallets of today may no longer be supported by the time of your passing.

Estate planning for cryptocurrency investments should also include preparations for someone in a fiduciary or executor role who is appointed to safeguard the control of those tokens for a period. Suzy Walsh, American College of Trust and Estate Council Fellow, explained that crypto investors should be particularly careful when selecting a fiduciary. 

“Fiduciaries are supposed to keep things safe and manage them…they’re not supposed to be holding volatile assets” like crypto tokens, she said. She added that fiduciaries are not equipped to handle and retain cryptocurrency securely.

On the other hand, investors can make use of the volatility inherent to the crypto market when it comes to taxes. By gifting tokens at a time when values are low, for example, investors can minimize transfer taxes. Ideally, a fiduciary should also be comfortable with this aspect of crypto management.

The Bottom Line

The various security measures used to protect crypto holdings can, unfortunately, make it difficult for an investor’s next of kin to gain access. To protect your assets while also ensuring that you have a plan in place for them after you die, take time to include them in your will, designate beneficiaries, communicate clearly with those beneficiaries about what you own and how they can access it, and to secure documentation including wallet addresses and private keys or custodial passcodes. 

If you do expect to name a fiduciary, take care to ensure that the individual knows cryptocurrency well and is prepared to navigate volatility and security concerns while they oversee your holdings.