“Avoid This IRA Rollover Trap”

Reader Question: I was unaware of the once per year rule, and in 2016 I took a partial distribution simultaneously from two different IRAs: one Traditional and one Roth. I took these distributions twice within a six-month period in 2016. Both times, I returned the funds, to the penny, within 60 days, back into the originating accounts from which they came. I did nothing with the distributions except take the money out and within 60 days put it all back in. Are there any tax consequences for having done this? If so, how can I correct my mistake and/or limit the damage? What course of action would you recommend?  G.C.

Answer: I believe it was January 2015 that the IRS changed the rules about how often you can do a ’60-day Rollover’.  First, let’s start with an understanding of the two ways to rollover an IRA:

  1. Direct Transfer. With a direct transfer, you request that your current custodian move your IRA to another custodian by way of a trustee-to-trustee transfer.  This means you never touch the money and the two custodians communicate directly with each other.  Because you never ‘touch’ the money, there is no limit on how many of these transfers you can do.
  2. Indirect transfer. This is also sometimes referred to as a ’60-Day Rollover’.  Under this method, you request your IRA custodian send your money directly to you in the form of a check.  Once the money is received, you have sixty days (from the issue date on the check) to deposit the money into another IRA account.  During that sixty-day period, you can do whatever you like with the money.  If you fail to re-deposit it within the sixty-day period, you have effectively taken receipt of the money and it is taxable as if you simply cashed it in.  in addition, if you are under age 59½, you’ll owe a 10% federal penalty.

Here’s What’s Changed

Under the old rules, the taxpayer could use the 60-day rollover for each IRA once every twelve months.  People would abuse the rule by splitting up their IRAs into multiple accounts and ‘stagger’ the withdrawals so as to have direct access to funds for months at a time.  The courts stepped in and changed the rules…now allowing only one indirect transfer within a twelve-month period and this includes all of your IRAs (including Roth IRAs).  To be perfectly clear: That’s one indirect rollover in a twelve-month period (not a calendar year).  If you make the mistake and do, say, two indirect rollovers within twelve months, the second one (the ineligible one) is treated as an ‘excess’ IRA contribution and is subject to a 6% federal penalty each year it remains in the IRA account.  This is in addition to being subject to ordinary income taxes and potentially the 10% early withdrawal penalty in the tax year the rollover was made.  Exempt from these harsh rules are 401k-style plans being rolled over to an IRA and IRA rollovers to Roth IRAs.

How do you fix this mistake?

A review of the IRS website suggests that there is a waiver, but it is only available for “circumstances beyond your control,” which does not appear to apply in your case. My suggestion is to have your CPA contact the IRS to see if they will offer any leniency.  For all the other readers, I strongly recommend only direct IRA rollovers.