A new year always brings new opportunities and new challenges for advisors. This year also brought substantial rule changes, including a stricter interpretation of the once-per-year IRA rollover rule. Advisors must be sure to inform clients of the new regulations before they attempt to make any 60-day rollovers.
Failing to do so could lead to a fatal IRA error.
There are two ways to move IRA money to another IRA: directly and indirectly. A direct transfer, or a trustee-to-trustee transfer, happens when funds move from one IRA to another without the client touching the money. These can be done as often as you wish, without worrying about the once-per-year rollover rule. Always move IRA funds directly if possible.
Yet some employees at financial institutions may still suggest an indirect transfer, also called a 60-day rollover. In these transfers, clients receive a check from their IRA, made out to them. They then have 60 days to redeposit or roll over the money to another IRA, or even back to the same IRA.
The new interpretation of the once-per-year IRA rollover rule makes the 60-day rollover even riskier now.
One key issue: You only get one chance a year to make an indirect transfer. A second rollover made within one year of the first 60-day rollover could cause a taxable distribution, plus a 10% penalty if your client is under the age of 59 ½. If the rule is violated, clients could even lose their IRAs making the entire account essentially a taxable distribution and the IRS has no authority to provide relief.
It may get worse. If an IRA holder errs by doing a second 60-day rollover within the year, the IRS views this as an excess contribution, subject to a 6% penalty for every year the ineligible rollover funds remain in the account. This would be on top of the taxes and 10% penalty fee already levied.
This new interpretation of the rollover rule constitutes a significant change from the past. For many years the IRS guidance said that the once-per-year rule applied to each IRA separately, meaning a client with four separate IRAs could make four rollovers within the same one-year period.
That interpretation, however, was turned upside down last year, when the U.S. Tax Court issued a landmark ruling in Bobrow v. Commissioner, stating that the rule applies to a persons IRAs in aggregate. With this decision, the IRS realized it had a big problem on its hands: Its interpretation of the once-per-year rule had been wrong all along.
What, then, was the IRS going to do about those who acted on the old, more generous interpretation? Did those clients have invalid rollovers? This was a potentially serious and costly problem for those taxpayers.
Fortunately, the IRS realized how unfair it would be to create such difficulties for clients who had followed the agencys own guidance. In Announcement 2014-15, released shortly after the Bobrow decision, the IRS said it would not begin to enforce the new interpretation of the rule any earlier than 2015.
Still, questions remained. Would the IRS begin to enforce the new interpretation this year and then look back at the prior year to see if another rollover had been made, violating the rule? That was certainly a possibility.
Thankfully, this will not occur; the IRS says it will enforce its new interpretation of the once-per-year rule only for rollovers made in 2015 and thereafter. Any rollovers initiated last year will not affect rollovers this year.
Note, however, that the once-per-year rollover rule has always prevented a second rollover when the distribution comes from an account that either distributed or received a rollover within the past year.
Say your client took a distribution from IRA No. 1 on Nov. 30, 2014, then rolled over the funds to IRA No. 2 in December 2014. She also has a third IRA. If she wants to, she can take a distribution from IRA No. 3 at any time this year and roll over the funds, because her 2014 distribution and rollover from IRA No. 1 wont count toward the once-per-year limit.
However, she cannot roll over a distribution taken from either IRA No. 1 or IRA No. 2 to another IRA before December 2015. That would be a violation of the once-per-year rollover rule that has always been enforced.
Now take another client with three IRAs. He took a distribution from IRA No. 1 last month and rolled it over to IRA No. 2 in a timely manner. He now cannot do another 60-day rollover from any IRA account for the following 12 months. (He still can do trustee-to-trustee transfers, however.)
ROTH VS. TRADITIONAL
Unfortunately, for the purposes of the once-per-year rule, the new guidance says traditional and Roth IRAs get combined. A distribution and subsequent rollover between a clients Roth IRAs will also prevent another rollover between that clients traditional IRAs during that one-year period. And the reverse, of course, is also true. In other words, if a client has both a Roth and a traditional IRA, he can roll over a distribution from only one of those accounts within the one-year period.
Consider yet another client this one with three traditional IRAs and two Roth IRAs. He took a distribution from one of his IRAs in January and rolled it over to one of his other IRAs. He cannot do another 60-day rollover from any of his IRAs or Roth IRAs for the following 12 months although, again, he can still do unlimited trustee-to-trustee transfers.
Notably, Roth conversions are exempt from the once-per-year IRA rollover rule so if that client wanted to convert one of his IRAs to a Roth IRA after he did the IRA rollover, that would be OK. (With a Roth conversion, of course, the funds are being rolled over from a traditional IRA to a Roth IRA, not from a traditional IRA to another traditional IRA.)
Under the new guidelines, if an IRA owner receives a distribution in the form of a check made payable to the receiving IRA custodian, it will be treated as a trustee-to-trustee transfer. An IRS regulation has long allowed direct rollovers from plans to be made in a similar manner, but there had been some speculation as to whether a similar rule would apply to IRA distributions. That question has been answered definitively.
This means that if, for some reason, an IRA custodian wont send IRA funds directly to another IRA custodian or if the timeline for doing so is unacceptable a client can request a check made payable to the new IRA. Since the client doesnt have control or use of the money, it will be considered a trustee-to-trustee transfer and will avoid problems associated with 60-day rollovers.
Advisors should immediately warn new clients who are thinking of rolling over their IRA funds. Ask if funds have been rolled over from any IRA or Roth IRA in the past year. If so, the only way you can bring these funds over is with a direct transfer.FP
Ed Slott, a CPA in Rockville Centre, N.Y., is a Financial Planning contributing writer and an IRA distribution expert, professional speaker and author of many books on IRAs. Follow him on Twitter at @theslottreport.
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