What You Need to Know About the 60-Day Rollover Rule: IRA Rollover Mistakes You Should Avoid
Indirect Rollover, IRA Loans, and Tax Penalties
Just the other day, I sat down with two of my clients and I walked them through their retirement consolidation, investments, and cash flow plan. These two clients were a couple. For the purpose of this article, let’s call them Mr. and Mrs. Jack and Jane Smith.
We completed an intensive investigative process, which helped me learn a lot about their financial situation when we first sat down. I proposed a plan to help Jack and Jane understand their benefits and accomplish their financial goals.
Eventually, the conversation began heading towards the logistics of how to fill out the paperwork to do an IRA Rollover from Jack's 401(k). Jack and Jane wanted to make sure that the money they selected to invest towards the new strategy would be deposited directly into their Rollover IRA, which was recently set up. Then, Jack asked me the following question:
Jack: “Why can’t I just have the check made out directly to myself?”
Nick: “Well, Jack, that is called an Indirect Transfer and it can potentially cause some tax penalties. We believe that the best practice is to always do trustee-to-trustee transfers.”
Jack: “What does that mean? And frankly, I’m not too sure I feel comfortable having this much money payable to Fidelity, even if it does include the words, ‘for the benefit of Jack Smith’.”
Straightaway, this led us into an in-depth conversation about IRS Announcement 2014-32.
As many people may know, the IRS allows a financial transaction called a 60-day rollover. This is where an individual may take a withdrawal from one qualified retirement account and roll te proceeds into another qualified retirement account within 60 days without any penalties.
Before, the rule used to allow an unlimited amount of IRA rollovers as long as the withdrawal and deposit were both made into the next IRA within a 60-day period. Unfortunately, most people are not familiar with the new announcement from the IRS. Today, only one 60-day rollover is allowed within a 365-day period. Only One. If an additional rollover occurs within a 365-day period then the distribution will be taxable and possibly subject to penalties.
Previously, advisors encouraged the prolific use of the 60-day rollover rule so much so that special strategies were developed to take advantage of it. One of the more well-known strategies is the IRA loan. In this strategy, an individual, like Jack, might have a short-term need for money.
For example, let’s say that Jack and Jane are purchasing a new house and selling their current home. The problem is that their new house purchase is closing before the current house sell. They need the 20% for the down payment. Jack may decide to take the money out of his IRA and use it for the deposit. When their home sells, he can put the money back into his IRA within 60 days without any taxes or penalties. The problem is that if Jack either already made a 60-day rollover in the last 364 days or chooses to make an additional 60-day rollover in the next 364 days, then it will void the IRA loan. The second transfer can potentially cause taxes and early withdrawal penalties; this can easily happen in situations as follows:
1) Jack decides to consolidate IRAs.
2) Jack may have an IRA CD at a bank that automatically renews and rolls over to a new IRA.
3) Jack cashes out an IRA annuity and the annuity company makes the check payable directly to him.
4) Jack's advisor does not advise him differently during the proposed consolidation plan.
Given these points, retirees, such as Jack and Jane Smith, are not the only ones unaware of the new rule change, but some financial professionals may not provide the correct advice to their clients. In light of the new rule change, Ed Slott, a CPA and advisor in Rockville Center, recently wrote an article on Financial-Planning.com. Slott illustrates how advisors, bank tellers, and many others are giving out dangerously incorrect instructions. It is so easy to slip up and incur penalties which is why Slott recommends to, “Never, ever, take in new client IRA or Roth IRA money as a 60-day rollover. Only use direct transfers. Advisers don’t know the history of the clients’ other IRA rollover transactions in all their other IRAs and Roth IRAs for the last 12 months. If another 60-day rollover was done, the new client IRA rollover cannot be done and the funds must be distributed and subject to taxation.”
It’s great advice for advisors and clients. If you are ever moving money between IRAs and/or other qualified accounts, we recommend to always do trustee-to-trustee transfers. In the case of a slip up on your part, or anyone else’s, then you are less likely to find yourself in hot water in regards to the 60-day rollover rule.
