Knowing the Rules Can Help Prevent Invalid IRA Rollovers
By Jodie Norquist, CIP, CHSP
Your clients request rollovers between their IRAs for many reasons. They may want to consolidate their IRAs, perform a Roth IRA conversion, move their accounts to another financial organization, or, perhaps, use their IRA assets for up to 60 days before returning the money to the account. But if they don’t follow certain rollover rules, it could turn into an invalid rollover. An invalid rollover can be a costly mistake for your clients—and a headache for your organization as it works to maintain compliance and to correctly report IRA rollover transactions. Keep in mind the following rules before accepting a rollover contribution.
Required Minimum Distributions
Very often, an invalid rollover involves required minimum distributions (RMDs) that have been rolled over to an IRA. Once an IRA owner turns 72, she must start taking annual distributions from her Traditional IRA (or SIMPLE IRA). These RMD amounts generally have to be out of the IRA by December 31 each year and must stay out; they cannot be rolled back in or to another IRA. This also pertains to Roth IRA conversions; RMDs cannot be rolled over from a Traditional IRA to a Roth IRA as part of a conversion.
RMD rules require that any distributions up to the annual RMD amount that are taken by an IRA owner who is of RMD age are deemed to be the IRA owner’s RMD. In other words, the first dollars out are considered RMD dollars. The tricky part is that RMD amounts may be transferred, or directly moved, between IRAs. With such nonreportable transactions no distribution occurs. But as soon as an IRA owner takes a distribution (i.e., has constructive receipt of the assets) from any non-Roth IRA, that distributed amount is considered an RMD.
Although RMDs from multiple IRAs can be aggregated and removed from one IRA, a rollover from any of the IRAs cannot occur until after the IRA owner’s annual RMD obligation has been satisfied. If the annual RMD is not satisfied, deemed RMD amounts rolled over will result in an invalid rollover.
Example: John, age 74, owns two Traditional IRAs: one at ABC Financial and one at XYZ Brokerage. He has aggregated the RMD amounts from each and, at ABC Financial, set up automatic monthly distributions to satisfy the aggregate RMD amount by year end. Now, in September, he wants to roll over assets from his IRA at ABC Financial to another financial organization. Because it’s September and he hasn’t yet distributed his aggregate RMD amount in its entirety, he’ll need to distribute the remaining RMD amount before rolling over the rest of the ABC Financial IRA assets to the new financial organization. If he rolls over the remaining RMD amount, the result will be an invalid rollover.
One-Per-12-Month Rule
An invalid rollover may also occur if the rollover violates timing restrictions.
IRA owners are not limited to a certain number of transfers but are limited to only one IRA-to-IRA rollover in a 12-month period—regardless of how many IRAs they may own. The 12-month period starts with the date of the IRA distribution. Any IRA-to-IRA rollovers beyond one in a 12-month period are invalid. This rollover limitation, however, does not apply to rollovers between IRAs and eligible retirement plans or to Roth IRA conversions.
60-Day Rule
IRA owners have 60 days to complete an IRA rollover. The clock starts ticking the day after the individual receives the distribution. An IRA owner may choose to make multiple rollover contributions—returning parts of a single distribution to an IRA—within those 60 days, but the rollover time limit is based on one distribution. Rollovers that occur past the 60-day period without a valid waiver or extension are invalid.
Invalid Rollovers Could Turn Into Excess Contributions
Any ineligible amounts, including RMDs, rolled over to an IRA become regular IRA contributions. If the IRA owner wasn’t eligible to make a regular contribution for the year or had already made his maximum IRA contribution for the year, the ineligible rollover amount-turned-contribution would be subject to the excess contribution and penalty tax rules.
To help your clients avoid invalid rollovers, encourage them to seek competent tax advice, as well as to reference Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), and Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), for the rollover rules. And before your financial organization accepts rollover contributions from clients, ask qualifying questions to be sure that they’ve taken their RMDs, if applicable, that 60 days haven’t passed since funds were distributed, and that they haven’t had another rollover in the previous 12 months. Doing so can help them avoid unpleasant tax and penalty consequences.
