Moving IRAs? You Gotta Know When to Roll ‘Em

Untold numbers of IRA owners are going to get slammed by a new rule that took place on January 1st which limits you to one (indirect) IRA-to-IRA rollover per year.   This is a major change for two reasons.

First, it re-writes a process that has been in place for three decades and is widely used by millions of Americans.  Second, it is an extremely expensive mistake!

The Way It Was

People often move IRA money via what’s called an “indirect transfer.”  That is, they close out one IRA, receive a check in their name for the proceeds and then deposit the check into another IRA.  As long as this is completed within 60 days, there is no problem- you do not have to pay income tax on the withdrawal and there is no 10% penalty for taking money out of your IRA before age 59½.  Moreover, prior to the start of this year, you could move assets from one IRA to another as many times as you wished.

Here’s what has changed: no matter how many IRAs you own, you are now limited to one indirect transfer every 12 months. Notice that the timeframe is not per “calendar year,” but once every 365 days.  So you need to keep track of the dates involved.

Up to now, the “one-indirect-rollover-per-year” rule applied to each IRA on an individual basis.  You could roll IRA “A” to IRA “B” and you could also roll IRA “C” to IRA ”D.”  But you had to wait a year until you moved the assets in either “B” or “D” again.  Now, the rule aggregates all  IRAs that you own.

The result?  If you pull money out of an IRA, receive a check made out to yourself and then re-deposit this into another IRA, you have to wait 365 days to do this again.  An indirect transfer from one Roth IRA to another also counts toward the “once every 365 days” limit.

Serious Consequences

Let’s say you didn’t know about this. You retire later this year and want to simplify your financial life by consolidating all of your accounts in one place.  You go to your local bank and close out the IRA you have there.  You do the same with the credit union and the mutual fund company where you sent the 401(k) money from an old employer.    Each entity gives you a check made out in your name.  Within the 60-day rollover window, you deposit all three checks into your new IRA at Financial Institution X.  Mission accomplished!

A year later you get a letter from the IRS telling you that violated the one-per-365-days rollover rule.  Two of the three rollovers are disallowed.  You must withdraw the money.

If the assets came from traditional IRAs, you have to pay income tax on the entire amount.  If you are under age 59½, you will also get hit with the 10% early withdrawal penalty.  Perhaps the most significant impact is that these funds will no longer enjoy the tax-sheltered advantages of an IRA.  Going forward, all earnings will be subject to income tax on an annual basis.

“Older people change IRA investments all the time just to get a half percent more on a CD at another bank!” says CPA Ed Slott, who writes and speaks about IRAs.  Better tell  grandma that if she does this more than once within a 365-day period, she’ll lose a big chunk of her retirement nest egg.

No Relief in Sight

If you somehow miss the 60-day window for re-depositing an IRA rollover, the IRS has a fair amount of leeway to grant you a reprieve.  Acceptable excuses range from, “My financial advisor goofed” to “I was in jail and could not complete the rollover in the time allotted.”  (No joke.)

But there is no provision for penalty relief if you exceed the number of indirect rollovers you execute in a year!   It won’t help to hire a tax attorney. No amount of crying or pleading can get you out of the consequences.

In fact, the guy who brought this rule change about was a tax lawyer who did a number of rollovers involving his own and his wife’s IRAs in a very short period of time that the court questioned.  In ruling against him, the court clarified that “the one-year limitation…is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer.”

Go Direct!

Fortunately, there is a simple way to avoid any complications. According to tax guru Bob Keebler, who holds a Masters degree in taxation, just don’t do an indirect transfer! Instead, move the money via a “direct” transfer, that is, from the current to the new trustee.  Most IRA custodians will send the money to your new custodian electronically. “If you do a direct transfer, you can do a hundred rollovers a year without any problem,” says Keebler.

Slott says there’s a additional way to do a “direct” rollover. “If your bank insists on giving you a check, have it made out to the receiving account and not to you.  Then the rule does not apply.”

The critical component of either approach is that it’s impossible for you to get your hands on the money during the 60-day rollover period.  This negates your ability to use your IRA for a 60-day, interest-free “loan,” something the IRS frowns upon.

To Re-Cap

It’s important to understand what is not affected by this rule change and therefore does not count toward the limit of one rollover/year.  You can make an unlimited number of the following moves:

• Rollover from a 401(k)(2) to an IRA
• Rollover from a traditional IRA to a Roth IRA (this is considered a “conversion”)
• Trustee-to-trustee transfer between IRAs (a.k.a. “direct transfer”)