Financial Poise
Avoid taxation following these IRA rollover rules

Little-Known IRA Rollover Rule Has Big Consequences

Explaining Direct Rollovers, 60-Day Rollovers and the One-Per-Year Rule

Little did Alvan and Elisa Bobrow know their decision to consolidate their IRAs into a single account would make the Forbes list of Top 10 Tax Cases of 2014.

According to U.S. Tax Court records, the Bobrows elected the indirect rollover option for their transactions. Up to that point, precedent said that the IRS-mandated that 60-day penalty-free window would apply to each of their accounts from the time they received their assets to the point they rolled them over to the new account.

That’s when things got complicated—and the couple earned a place in tax court history.

Instead of allowing the indirect rollover rule to apply to each of their IRAs separately, the U.S. Tax Court ruled instead that only one indirect rollover per year could be completed without a penalty—regardless of the number of IRAs.

“The court’s ruling directly conflicted with long-standing precedent,” recalled retirement specialist Ed Slott in Investment News.

Why It’s Important to Know Your IRA Rollover Rules

A rollover IRA allows investors to transfer their assets from one type of account (e.g., an employee-sponsored plan) to a traditional IRA—which affords a wider range of investment options—without losing tax-deferred status.

According to a TIAA survey, 28% of workers prefer to roll over their assets into an IRA (about the same amount of workers who prefer a pension or lifetime retirement income distribution), while only 6% prefer a lump-sum withdrawal. Many retirement assets will end up as IRA rollovers, and because of financial fears surrounding COVID-19, ROTH IRA conversions have seen a surge of 76% in the first quarter of 2020.

For both investors and financial advisors, the importance of IRA rollover decisions keeps growing, so it’s important to know IRA rollover rules and how to avoid losing tax-deferred status.

4 Tips for Completing IRA Rollovers the Right Way

1. Limit to One Indirect Rollover a Year

The IRS states: “You can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own.” If the rule is not followed, investors will pay a 10% early withdrawal tax on the amount included in gross income.

This rule does not apply to the following:

  • Rollovers from traditional IRAs to Roth IRAs (conversions)
  • Trustee-to-trustee transfers to another IRA
  • IRA-to-plan rollovers and vice versa
  • Plan-to-plan rollovers

With some rule violations, it’s possible for investors to lose their IRA investment status entirely, making the account essentially a taxable distribution.

2. Weigh the Options: Direct or Indirect Rollover?

You can move IRA money to another IRA directly or indirectly. But what does this mean with regards to the IRA rollover rule?

A direct rollover allows investors to move their assets from one IRA to another without being touched or “cashed out” by the investor. This is also the case for a trustee-to-trustee transfer. The one-per-year rule does not apply for these types of rollovers.

Indirect transfers, on the other hand, require more care and attention, as investors are limited to one indirect rollover per year. An indirect rollover, called a “60-day rollover,” is when investors withdraw their assets or receive a check from their provider. Investors then have 60 days to roll over the money to another IRA (or even back to the same IRA) to avoid a tax penalty. The tax penalty may be waived under certain circumstances, including COVID-19-related instances.

3. Remember that Roth IRAs Count, Too

The IRA rollover rule does apply to Roth IRAs, but only in the instance that a distribution and consecutive rollover between Roth IRAs is made.

In contrast, Roth conversions receive an exemption from the once-per-year IRA rollover rule. (After all, the IRS already taxed the accounts initially.) Converting from a traditional IRA to a Roth IRA after a rollover is acceptable.

4. Consider the Trustee-to-Trustee Method

For retirement-minded investors who don’t want to manage a calendar of rollover events, there may be another option. An investor can elect to receive a distribution in the form of a check already made payable to the receiving IRA custodian.

In this case, the IRS considers those funds as a trustee-to-trustee direct transfer.

In cases where funds have rolled over from any IRA or Roth IRA in the past year, clients may be better served by transferring their funds directly—and skip receiving the payment directly.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Basic Investment Principles 101 – From Asset Allocations to Zero Coupon Bonds and All About Asset Allocation. This is an updated version of an article originally published on July 19, 2017.]

©All Rights Reserved. September, 2020. DailyDACTM, LLC d/b/a/ Financial PoiseTM

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