How to do a IRA Rollover Correctly

Messing up a rollover can be expensive

Generally, anytime monies are moved from one IRA account to another IRA account, the transaction is thought of as a “rollover”. Technically, according to the tax law, the only time the term rollover properly describes the money movement is when a check is taken by the IRA owner from one IRA and physically deposited with the financial institution to be credited to a second IRA. The direct trustee-to-trustee transfer of monies electronically is not a rollover. The distinction is critical; for when a transfer of monies is done via check or electronically, all of the tax rules regarding rollovers come into play. They do not come into play when there is a direct transfer-to-transfer transaction.

Rollover Rules

When funds are withdrawn from an IRA account, usually by check, to be deposited into another IRA account or redeposited to the same IRA account, the deposit must be made in 60 days or less, measured by the date on the check to the date of deposit.

The tax law allows only one rollover per IRA account in a twelve (12) month period. The twelve month period begins on the day the IRA owner receives the distribution, not the day the distribution is actually rolled into the new account or rolled back into the old account.

For example: if the IRA owner receives a $25,000 check dated February 1, 2008 from Fidelity’s Select Medical Equipment Mutual Fund, which had a balance of $29,000, and rolls it into another IRA account on March 1, 2008 at Citizens Bank, another rollover cannot be started until February 2, 2009. This means no rollover can be started from any funds remaining in the Fidelity Select Medical Equipment Mutual Fund until after February 2, 2009 and no rollover funds can go into Citizens Bank until after February 2, 2009.

This one-in-12 month rollover rule applies separately to each individual IRA account. This means that the IRA owner who receives a check from Fidelity’s Select Gold Fund and rolls it into a separate IRA rollover CD at Citizens Bank can do so within the same 12 month period as the rollover from the Fidelity Select Medical Equipment Mutual Fund.

However, a trustee-to-trustee transfer can be done more than once a year.

What Happens If the 60 Day Period Expires

If the 60-day rollover requirement is not met, the distribution is taxable as ordinary income. In addition, if the IRA owner is less than 59 ½ years old, the rollover amount, less any cost basis, is subject to the 10% penalty on premature distributions.

Trustee-to-Trustee Transfers

This method of transferring funds from one IRA account to another is often called “a direct transfer or direct rollover”. Under this method, the IRA owner never lays a hand on the funds. The transfer is done directly from one financial institution to another. This method removes just about all of the problems associated with the rollover method.

If a plan document does not allow direct transfers, the check can be issued in the name of the IRA account instead of the IRA owner directly. For example: John
Doe IRA. John Doe cannot cash the check because it is not made out to him.

Waiver of Rollover Taxes and Penalties

Beginning in 2002, the tax laws allowed the IRS to grant waivers of the 60-day rule allowing an extension of time to accomplish a rollover in situations where it would be unjust to tax and penalize the rollover. Subsequently, in January 2003, the IRS issued Revenue Procedure 2003-16 spelling out guidance for applying the waiver. Basically, the Rev. Proc. says taxpayers may file for a private letter ruling. The Rev. Proc. also gives automatic relief in cases where the financial institution was at fault.

Examples of waivers granted by IRS from the 60-day rollover rule pursuant to private letter ruling requests:

1)    Advisor stole money from IRA accounts.
2)    Rollover funds mistakenly deposited to a taxable account.
3)    Inability to complete a rollover due to death, physical disability, hospitalization, incarcertation, mental disability, postal error, or restrictions imposed by a foreign country.
4)    Alzheimer’s disease
5)    Financial institution deposited monies in a taxable account
6)    Advisor deposted monies into a taxable account.
7)    Bank closed early on the 58th day and did not reopen until the 62nd day.

Examples of private letter ruling applications seeking to avoid the imposition of the 60day rule which were denied by the IRS:

1)    IRA owner used the IRA funds to live on during unemployment period.
2)    IRA funds used to cover personal expenses beyond 60-day period.
3)    IRA owner used IRA distribution to offset capital gains (IRA distributions are ordinary income and do not offset capital gains).
4)    IRA owner withdrew funds to avoid an IRS tax levy.
5)    IRA funds used to pay tuition.
6)    IRA funds used to purchase a home.
7)    IRA funds rolled into a trust (a nonspouse beneficiary)
8)    IRA owner opened mail containing distribution after 60 days had passed and deposited the check in a taxable account.
9)    IRA owner withdrew money from IRA account for a rollover but forgot about it while studying another investment.
10)    IRA owner rolled IRA into another financial institution but did not specify the new investment; the institution sent the check back and IRA owner never cashed it thinking it did not constitute a rollover.
11)    IRA owner used rollover funds as a short-term bridge loan for a real estate transaction but 60 days passed due to complications.

The fee for filing a private letter ruling application with IRS is now $9,000. Tax practitioners also charge fees to prepare the applications, which is not simple to prepare. The best way to avoid potential costs and taxes: use a trustee-to-trustee transfer; there is no limit on the number of times per year a trustee-to-trustee transfer is done.

Ineligible Rollovers

A nonspouse beneficiary cannot do a rollover. An inherited IRA cannot be rolled over. If you know you will inherit an IRA, do not ever accept an inherited IRA in your own name. It will be immediately taxable.

A trust IRA cannot be rolled over. It is a nonspouse beneficiary.

As estate IRA cannot be rolled over. It is a nonspouse beneficiary.

Do not withdraw funds from an IRA account to avoid an IRS levy and leave them outside the original IRA account for more than 60 days. There is no waiver of the rollover rules in this case.

Do not sell property, securities, bonds, etc. that come out of an IRA which are intended for rollover to another IRA and use the cash to roll into the second IRA. It is an ineligible rollover.