Understanding IRA Transfer and Rollover Rules
If you have ever had any sort of retirement plan with your employer, you have probably at least heard the term “rollover.” Until recently, this term has generally referred to the process of moving your retirement funds from your employer-sponsored retirement plan to your own Individual Retirement Account (IRA), any number of times per year.
Now that’s no longer the case. Effective January 1, 2015, a 2014 Tax Court opinion – Bobrow v. Commissioner, T.C. Memo. 2014-21 ¬– has made it very important to be highly specific in the process and vernacular that is used in the movement of your retirement funds to avoid possible taxes and penalties.
Why is that, you ask?
According to this opinion, and clarification from the IRS, a “rollover” now occurs any time funds from a retirement account are sent to the participant, made out in the participant’s name. This is all fine and dandy as long as the participant then “rolls over” the funds into an IRA or another employer-sponsored plan within 60 days. Otherwise, the full amount withdrawn becomes subject to taxes and possible penalties.
It used to be that this kind of operation could be accomplished several times within a calendar year. We have even seen the “robbing Peter to pay Paul” maneuver used by couples who have multiple IRAs. They would withdraw funds from one IRA and then, (before the 60 days is over) withdraw funds from the spouse’s IRA to repay the first IRA…and on and on.
But now, according to this new IRS ruling clarification, you can only do one of these rollovers per year, per person, across all IRAs. If someone happens to do this twice in one 365 day period (not calendar year) the second distribution will be subject to regular taxes, (up to 39.6%) penalty (10% if under 59 ½) and a special excise tax of 6% for a possible grand total of 55.6%!!
Needless to say, this is a situation to be avoided.
Below are two common scenarios where people may find themselves in trouble.
Scenario 1: Bob just retired from XYZ Corporation and decides to move his 401(k) funds to his already established Traditional IRA. During this process, the 401(k) custodian makes the check payable to Bob and mails it to him directly. Bob then deposits the check into his IRA and all is well.
Now that he is retired and in an effort to consolidate, he decides to move his funds from a previous employer’s 401(k) to his IRA as well. Unfortunately, this 401(k) custodian does the same thing as the other custodian and makes the check payable to Bob and sends it to him. Since this happened within a 365 day period, the second rollover becomes subject to taxes and penalties.
Scenario 2: Mary has two different IRAs with two different custodians and advisors. She finds a new advisor and decides to work exclusively with the new advisor. So, she begins the transfer process of both IRAs to the new custodian with the new advisor. Unfortunately, both of her old custodians make the check payable to her and therefore one of the rollovers becomes subject to taxes and penalties.
Avoid Indirect Transfers Whenever Possible
These can happen in many different situations, but the common denominator is when the funds are made payable to the individual and not the new custodian. The difference is whether the distribution is a direct transfer (custodian to custodian) or an indirect transfer where the checks are made payable to the individual. You can make as many direct transfers as you want in any given 365 day period, but you can only make one indirect transfer or rollover.
Also, it is important to note that the interpretation combines all of one person’s IRAs and Roth IRAs when considering this action. This means that you cannot complete both a Traditional IRA indirect transfer and a Roth IRA indirect transfer in one year. It is an either/or situation.
Always Move Your Funds Directly
If you are in process of moving funds from a retirement plan (401k, 403b, etc.) or from an IRA to another plan or IRA, it is imperative that the checks be made payable to the new custodian or that the funds are electronically sent directly to the new custodian. If your current custodian says that they have to make the check payable to you directly, please know that they are misinformed and you should either ask for a supervisor or cancel the transaction and make the phone call later with your financial advisor.
So, you can still say TOE-MAY-TOE and I can say TOE-MAW-TOE, but we both have to be careful when using the term rollover.