A recent AARP survey found that more than half of adults over the age of 50 are worried about having enough money for retirement.
The applicable tax laws are: Rolling Over IRA Funds All of this is complicated, and some of the rules are strict and unforgiving – so violating any one of these rules can have devastating and costly consequences.
There are no do-overs: These errors cannot be corrected, so you must be extremely careful when transferring IRA funds.
Annual IRA Rollover Rules
One particularly insidious rule is limiting the number of IRA rollovers you can make.
For an IRA valued at $500,000, the combined income tax and penalties could result in an unexpected tax bill of more than $200,000, in which case you would lose your IRA. (iStock/iStock)
For example, you might want to move your IRA funds from one bank, broker, or fund company account to another, or from one financial advisor to another. For example, you might want to change advisors, investments, or banks. That’s OK. Just be careful about how often you move your funds.
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An IRA to IRA rollover (or Roth IRA to Roth IRA rollover) can only be done once per year, but not per calendar year; it’s 365 days. For example, if you do a rollover in December, you can’t do it again in January just because it’s a new year. You’ll have to wait 365 days until December of the following year before you can do your next IRA to IRA rollover.
This rule means that you can do something called a “60-day rollover,” meaning if you take your IRA funds out of one IRA and roll them over (deposit them) into another IRA, you have 60 days to put the funds back into the other IRA before it becomes taxable.
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If you miss the 60 days, you may be able to fix the mistake if you have a valid reason for not completing the rollover on time, such as illness, a death in the family, or an error by your financial institution. In these cases, the IRS can grant you an extension to the 60-day rule.
However, if you violate the once-per-year rollover rule, it’s a fatal error that can’t be reversed or forgiven by the IRS. You’ll owe taxes and lose that IRA. Plus, if you’re under age 59 1/2, you could be assessed a 10% penalty for early distributions.
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If your IRA is worth $500,000, you could end up with an unexpected tax bill of over $200,000, including income taxes and penalties. And your IRA is gone. 30 years of sacrifice and savings gone in 30 seconds.
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This strict rule has taken many by surprise, especially if you have multiple IRAs. The once-per-year rule applies to all IRAs, and applies to each IRA individually. Once you perform an IRA-to-IRA rollover, you are prevented from performing a 60-day IRA-to-IRA rollover in any other IRA for the next 365 days. This includes any SEP or SIMPLE IRAs you may have.
Fortunately, there are exceptions to this rule. The annual IRA rollover rule does not apply to rollovers from a 401(k) to an IRA or from an IRA to a 401(k). It also does not apply to rollovers from an IRA to a Roth IRA, because that is a taxable Roth conversion. The rule only applies to rollovers from an IRA to another similar type of IRA.
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Any reputable financial company or advisor should ask if you’ve done a rollover within the last 365 days before accepting your IRA funds. Even better, they shouldn’t even accept the funds as a 60-day rollover to protect you. But not all advisors will consider this or give you this advice (if they don’t, consider hiring an advisor who knows these rules).
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It’s a terrible system, but that’s the way the tax system works.
To avoid this from happening, follow these steps:
Do not do a 60 day rollover.
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Instead, when you do an IRA to IRA rollover, you arrange to transfer money directly from one IRA account to another without touching (withdrawing) the funds in between.
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If you only do direct transfers, you can make as many transfers as you like and the once-a-year rollover rule no longer applies because the funds are never physically withdrawn from the IRA. The funds are directly transferred. This method also means you don’t have to worry about the 60-day deadline because the funds are transferred instantly.
The lesson for anyone who has an IRA and wants to move funds around someday is to only do direct transfers, not 60 rollovers.
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