IRA Rollovers: Use Extreme Caution!

Take-Away: The simple message with regard to all IRA rollovers is probably to never do one. A failure to complete an IRA rollover in the mandatory 60 days produces draconian results for the IRA owner. Nor can an IRA owner make two rollovers within 365 days of one another, leading to taxation and penalties.  Consequently, it is always better to implement a custodian-to-custodian IRA transfer, which is neither subject to the normal 60 day rollover rule nor the one-rollover-per 365-day rule.

Background: Two key rollover rules must be followed. First, an IRA rollover from one IRA account to another IRA account must be completed by the IRA owner within 60 days of the owner’s initial receipt of the IRA assets. Second, there can only be one IRA rollover by the IRA owner in a 365 day period. While these basic rules seem simple enough on their face, mistakes abound.

Consequences of a Mistake: The failure to rollover the IRA assets from one IRA account to another IRA account in the 60-day ‘window period’ results in the entire amount as taxable to the IRA owner. Adding insult is that if the IRA owner is then under age 59 ½, there will be the additional 10% penalty for that ‘early distribution’ to the IRA owner. Assume that the rollover mistake is made and the 60 day window is missed,  and the IRA owner proceeds to place the withdrawn funds in their new IRA anyway. If that attempted-fix occurs  then there will be an excess contribution to the ‘new’ IRA and a 6% penalty will be imposed on the entire amount of that excess IRA contribution, each year, until the excess contribution is removed from the IRA. In sum, missing the 60-day rule results in the loss of the IRA as a retirement savings account. The result is pretty much the same if more than one rollover occurs in a 365 day period; the second distribution taken from the IRA by the owner within the 365 days of the first distribution/rollover will be treated as a taxable distribution of the second IRA distribution to the owner, and also exposing the owner to the 10% ‘early distribution’ penalty.

IRS Position on Rollovers: If the loss of IRA’s tax deferred status and a 10% or 6% penalty was not enough, the IRS has no statutory authority to waive the one-rollover-per-365-day rule. While last year the IRS published Rev. Proc. 2016-47 that allows some self-certification relief when the 60 day deadline is missed by the IRA owner [specifying the causes why the 60 day rollover was not completed within the ‘window period’, e.g. health; family death; natural disaster] that limited self-certification relief for missing a 60-day rollover does not apply to the one rollover per year rule. The IRS cannot waive, for any reason, the one-rollover-per-365-day rule. Thus, if the IRA owner blows the one-rollover-per-365-day limitation, the owner will have lost his or her retirement account and will have only a big income tax bill to pay.

Simple Solution: If the IRA assets are directly transferred  from one IRA custodian  to another IRA custodian, there is no 60-day rule, nor is there a one-time-per-365-day rule applied to that direct transfer. In short, an IRA owner can have as many transfers between IRAs annually without having to deal with these two rules that tend to trap so many IRA owners. This is a big distinction between an IRA rollover and a custodian transfer to keep in mind.

Rollover Traps: Some of the traps that an IRA owner might encounter when he/she decides to take a distribution and rollover the IRA funds in a 60-day rollover include:

• What is a Year?: A year is 365 days, not the calendar year. Just because a new calendar year shows up does not mean that a new IRA rollover can occur. Assume I took a distribution from my IRA intending to make an IRA rollover on June 15, 2016. I transferred the funds to my new IRA on July 24, 2016. I thus satisfied the 60-day ‘window period.’ Assume that I take another distribution intending to do another IRA rollover on February 20, 2017.  I cannot make the second rollover on February 20, 2017. 365 days did not pass since June 15, 2016. If I tried to do another rollover on February 20, 2017 it will not qualify as a  rollover; instead,  it will be treated as a taxable IRA distribution to me. The 60-day rollover period starts the day I received the IRA funds, June 15, 2016, not the date I moved those assets into the rollover IRA on July 24, 2016. Keeping track of the date of the first IRA distribution is critical if a rollover is planned.
• Spousal Rollovers: We all know that when one spouse dies and names their surviving spouse as the designated beneficiary of their IRA that the survivor can ‘roll’ the decedent’s IRA into the survivor’s own IRA which will normally continue the income tax deferral on the inherited IRA funds. Assume my wife does an IRA rollover of her IRA on June 15, 2017. I die on September 30, 2017, having named my wife as the sole beneficiary of my IRA- a conventional estate planning strategy. My widow decides one month later after my death to roll the inherited IRA received from me into her own IRA, which she is entitled to do under the income tax laws. Guess what? My widow just violated the one-rollover-per-365 days rule. PLR 201707001. To avoid making a second rollover within the 365 day period, my widow should do a direct custodian-to-custodian transfer, of her inherited IRA, not an IRA rollover.
• Multiple Distributions on Different Days: Assume that I take multiple distributions from two IRAs that I maintain. From one IRA I take $10,000 on April 20, 2017, and I take another $25,000 distribution on April 24, 2017 from my second IRA, i.e. each distribution is on a different day, but plan I roll all $35,000 from the two IRAs  at one time into a single new rollover IRA that I have established. That plan will not work. Each distribution from the separate IRAs is considered a separate IRA rollover, and [beating a dead horse] there can only be one rollover every 365 days. If I am still sitting on the IRA money and the 60 day deadline is approaching, I can mitigate the problem by transferring the $25,000 amount, albeit the second distribution, into the rollover IRA account within the 60 days, to lessen the income tax burden and penalty imposed. I would then pay an income tax on the $10,000 IRA distribution. If I had already deposited the $10,000 into my new rollover IRA account, when I realized that I had created a problem for myself, i.e. I had two rollovers within a single 365 day period, then I could add to the $10,000 initial IRA deposit, $15,000 from the second IRA distribution, to max out the rollover to the new IRA (the larger of the two distributions), so long as I am in the 60 day rollover period. I still have to pay a tax on $10,000, but that is better than paying a tax and potential penalty on the $25,000 second IRA distribution.
• Multiple Distributions-Different IRAs- Same Day: Assume that I maintain two IRAs with  two different IRA custodians. From one IRA I take a $40,000 distribution, and from the second IRA I take a $17,000 distribution, both distributions occurring on the same day. I then transfer all $57,000 into my new rollover IRA account. Only one of these two IRA distributions will qualify for the IRA rollover within 365 days, even though both IRA distributions are taken on the same day and transferred into the same new rollover IRA account. Again, in order to avoid taxation of one of the distributions, if possible,  I should arrange for a direct custodian transfer to the new rollover IRA, to avoid the second IRA being classified as a rollover.
• Roth and Traditional IRA Rollovers: Assume that I maintain both a Roth IRA and a traditional IRA.  I roll my traditional IRA into a new rollover IRA, and at the same time I roll my Roth IRA into a new Roth IRA, perhaps to a new IRA custodian for both. I just violated the one-rollover-per-365-day rule. Traditional IRAs  and Roth IRAs are combined for purposes of this one-rollover-per-365-day rule. In short, only one traditional IRA rollover to new traditional IRA, or one Roth IRA rollover to new Roth IRA rollover, is permitted by the owner every 365 days. Obviously, this problem can be avoided if one of the two IRA accounts is transferred and not rolled over with me touching the IRA funds.
• Required Minimum Distributions: [You have heard about this from me before.] An IRA required minimum distribution (RMD) cannot be moved as a 60-day rollover into another IRA. The RMD must be paid out first from the account before the remaining IRA funds can then be rolled into another IRA. Along the same lines, an IRA RMD cannot be converted to a Roth IRA, since a Roth conversion is treated as a The RMD must be paid out from the IRA first before the balance of the IRA can then be converted to a Roth IRA. The same rule applies with an RMD from an employer qualified plan; the first dollars coming out of the employer’s qualified plan are RMDs and thus they are not subject to being rolled into the participant’s IRA account.

Rollover Safe Havens: There are a few occasions when the one-rollover-per-365-day rule is not violated.

• One Distribution, Multiple Deposits: Assume that I take a $45,000 distribution from my traditional IRA. I then deposit $15,000 into new IRA #1, and I deposit the remaining $30,000 into new IRA #2, both deposits occurring within 60 days of my initial receipt of the $45,000. Both deposits meet the one-rollover-per-365 day rule because I received only one distribution, even though I decided to deposit the distributed funds into two separate rollover IRA accounts. The focus when implementing the one-per-365 day rule is on the number of distributions, not where the distributed money is  ultimately deposited.
• Multiple Distributions from One IRA on the Same Day: Suppose I have a $45,000 IRA account. I take a $30,000 distribution from my IRA in the morning. I then decided after additional consideration  to take the balance of my IRA as another distribution, i.e. the remaining $15,000 held in my IRA,  in the afternoon of the same day. Then, within the next 60 days, I deposit the combined $45,000 into my new rollover IRA. The IRS has inferred that both IRA distributions, occurring on the same day from the same IRA account, will be treated as a one distribution for rollover purposes. See Private Letter Ruling 9308050.
• Statutory Exemptions from the One-Rollover-Per-365 Day Rule: Some IRA distributions are exempt from the one-per-365 day rollover limitation. They include: (i) Roth conversions from traditional IRAs: (ii) rollovers from an employer’s qualified plan to an IRA, or vice-versa (from an IRA to the employer’s qualified plan where the owner participant maintains an IRA account); (iii) first time home-buyer distributions even if another rollover has occurred within the past 365 days; and (iv) qualified reservist repayments to their IRA.

Fixing Mistakes: If it appears that an IRA owner has taken a second distribution from their IRA within the 365-day  period, but still within the 60 day ‘window period’ there are a couple of possible solutions to the trap the IRA owner finds himself or herself in at that time.

• Roth Conversion:  Using the example above, I take two distributions from my two separate traditional IRAs within a close period of time ($30,000 from one and $15,000 from another IRA) when I am allowed only one rollover. I leave my $30,000 in my new rollover IRA using my one allotted rollover for the next 365 days. I then take the remaining $15,000 distribution and convert that amount to a Roth IRA ( that transfer is not subject to the 365-day rule.) I then later re-characterize my Roth IRA, in a custodian-to-custodian transfer, back into a traditional IRA ( again, this transfer is not subject to the 365 day rule.)  But this strategy works only if I discover my mistake of taking two distributions within the 365 day ‘window period’ and I act to correct the mistake within 60 days of my receipt of the earlier of the two separate IRA distributions.
• Rollover to Employer Plan: Using the same example, I rollover my $30,000 into a conventional rollover IRA account.  If my employer’s qualified plan accepts IRA rollovers, I then roll my remaining $15,000 IRA distribution into my employer’s qualified plan. Again, this transfer of an IRA into an employer’s qualified plan is not subject to the normal one-per-365-day rule.) Note, employer qualified plans must have a provision that indicates that the qualified plan will accept IRA roll-up’s into the plan; the employer sponsor does not have to include this provision in their adopted qualified plan.
• Check Payable to New Custodian: If I have the distribution check from my traditional IRA made payable to the new IRA custodian, i.e. the distribution check from my IRA is not made payable to me and is not in my name, and I deliver that check to the new IRA custodian within 60 days, that check will be treated as a direct transfer of my IRA assets and not a distribution that is subject to  the 365 day rollover rule.

Conclusion: While we tend to frequently mix the terminology that we use when we deal with retirement plan assets, it is important to always distinguish between a direct transfer by IRA custodian and a rollover IRA distribution to the IRA owner. Transfers are subject to neither the 60-day ‘window period’ rule nor the one-rollover-per-365-day rule. There is no IRS leniency if the 365 day rollover rule is violated, only taxes and potential penalties to be paid. Surviving spouses need to be alerted to the risks of a spousal rollover after the death of their spouse if an earlier rollover had been taken by the survivor within the prior 365 days. Finally, and most obviously, it is best to avoid all of these risks and use a direct transfer of an IRA account whenever possible.