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Watch Those IRA Rollover Rules!

Nov 9, 2012

A little planning advice could have prevented a $400,000 IRA rollover mistake. Have you ever heard of the "once per year" IRA rollover rule? Recently, an IRA owner lost more than $400,000 from his IRA because he violated this rule. To top it off, there appears to be no relief from the IRS for this IRA rollover error so there is no fix! Few people know and understand the 60 day IRA rollover rule which can be costly and result not only in 100% taxation of the amount of the rollover but also an additional 10% penalty for a premature distribution because the IRA owner happened to be under age 59.5. In some case there can also be a 6% excess contribution penalty. Anytime you move assets between IRA accounts you need to know this rule!

There is a "once per year" IRA rollover rule for IRA to IRA rollovers. What is a rollover? Well, a rollover occurs when money is withdrawn from an IRA account payable to the IRA account owner and deposited to another IRA within 60 days. When money comes out of an IRA and is received by the IRA account owner, it must go back into an IRA account within 60 days or the result will be a taxable distribution and perhaps a trigger of an additional 10% early withdrawal penalty.

This is different from what is known as the direct rollover which is a trustee to trustee transfer from one IRA account to another IRA account without the client receiving the funds. The direct rollover is not subject to the "once per year" IRA rollover rule. Here are the details surrounding the "once per year" rule; if an IRA owner completes a rollover from his IRA account, he may not complete another rollover from the same account during the following year (365 days). In addition, he may not perform any rollovers from the IRA account which received the rollover money during the same 365 day period. He could however perform a rollover from other IRA accounts.

Taking a look at a real life example always helps to better understand how the rule works. Here we go; Back to our IRA account owner with the $400,000 rollover mistake. We will call him Bob, the IRA rollover master.

On December 15, 2009 Bob withdrew $50,000 from mutual fund A IRA account and deposited the money into a non-IRA checking account. The withdrawal starts the clock for the 60 day rule to keep the funds tax deferred and clock for "once per year" rollover rule.

On February 1, 2010 he took $20,000 of the cash from checking and deposited into mutual fund B IRA account. So, he successfully met the 60 day rule to keep the $20,000 from income taxation by placing the cash back into an IRA account. The remaining 30,000 of the withdrawal was subject to income taxation but no penalty because Bob is over age 59.5. So far so good!

On June 1, 2010 Bob decided to move $400,000 of his mutual fund B IRA account to his non-IRA checking account. As it turned out, he did not need this money so redeposited $350,000 back into mutual fund B and $50,000 into mutual fund C account on July 15, 2010.

Even though Bob met the 60 day rule for all money withdrawn, he violated the "once per year" rollover rule. Because Bob had originally withdrawn $50,000 from mutual fund A IRA account and deposited $20,000 into mutual fund B IRA account on December 15, 2009 that meant no additional rollovers could be performed on either account for 365 days or until after December 15, 2010.

In this case, Bob had withdrawn $400,000 from mutual fund B IRA account within 6 months of his original rollover to mutual fund B IRA account. Therefore, the entire amount of the rollover of $400,000 is not valid and now becomes a taxable distribution. In addition because the rollover was invalid the $400,000 that was placed back into mutual fund B IRA account and mutual fund C IRA account now constituted excess IRA contributions for the year. This means Bob now owes tax on $400,000 plus a 6% excess contribution penalty if he does not withdraw the excess contributions timely from the IRA's. (By October 15, 2011 in this case)

In the end Bob had to pay income tax on these unintentional IRA distributions in excess of $110,000 all of which could have been avoided; not a good day for Bob and a banner day for the taxman.

It is all about proactive planning when moving your IRA account dollars; talk to your CERTIFIED FINANCIAL PLANNER ® Practitioner or Certified Public Accountant before you move your IRA assets. Here are some tips to help avoid unintentional IRA distributions;

  • Remember whenever you take money from an IRA account and place it into a taxable account, moving it back into an IRA account is considered a rollover even if it goes into the same IRA account,
  • A rollover must be completed within 60 days to keep the money tax deferred,
  • After a rollover takes place, neither IRA account (IRA where funds were taken or IRA which received the funds) can make a distribution eligible for a rollover for the next 12 months,. 
  • Perform direct trustee to trustee transfers where the IRA account owner does not receive the IRA funds when moving IRA money between IRA accounts; this avoids the "once per year" rollover rule,
  • The "once per year" rule applies to IRA to IRA rollovers only. It does not apply to employer retirement plans to IRA or IRA to Roth IRA conversions.

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