IRA Transfer vs. Rollover: The Retirement Move That Trips Up Savers
By Jodie Norquist, CIP, CHSP
When it comes to saving for retirement, most people understand the basics. They set up an IRA, begin making contributions, and let the balance grow. The stumbling block tends to happen later, when it’s time to move those funds. That’s when your clients hear terms like “transfer” and “rollover,” and may end up doing the exact opposite of what they should.
And unfortunately, a misstep with their IRA could create unexpected taxes and penalties. As a financial organization, your staff is working on the front lines. Your IRA owners will often assume that any movement of assets is a “rollover.” That’s where their confusion and potentially costly mistakes begin.
The $30,000 Mistake
Take this real-world scenario that our consultants hear about often on our 800 consulting lines.
Dave, a 57-year-old engineer, decided to move his Traditional IRA to another bank offering better investment options. He asked for a check written out to himself for the entire amount, $30,000, and deposited it into his personal checking account. Then a family emergency occurred, and he forgot about it. By the time he realized his error, more than 60 days had passed.
The result? The $30,000 is treated as a taxable distribution. Not only did Dave owe income tax, but because he was under age 59½, he also got hit with a 10 percent early distribution penalty tax.
Had Dave requested a transfer instead (i.e., had the check written directly to the receiving financial organization for benefit of Dave’s IRA), the funds would have moved seamlessly between the organizations with no reporting, no deadlines, and no panicked calls to Dave’s CPA.
Transfer: The Quiet Move
An IRA transfer is the easiest move to get right, but one that IRA owners rarely understand. It’s the invisible shuffle of money where assets go directly from one IRA custodian to another. With transfers,
no checks are written directly to the IRA owner,
·there is no IRS reporting,
the one-per-12-month rule does not apply, and
there is no 60-day deadline.
A transfer is the equivalent of wiring money behind the scenes instead of handing someone cash. The money can’t be spent by the IRA owner, so the IRS stays happily uninvolved. An IRA owner may take physical receipt of the check and bring it directly to the other financial organization, but as long as it isn’t written out to the IRA owner, but rather, to the financial organization for the IRA owner’s benefit, it is considered a transfer. A transfer could involve sending the money directly to the financial organization, too.
IRA owners can make as many transfers as they like, and none are reportable to the IRS.
Rollover: The Messy Cousin
IRA rollovers, on the other hand, are where things can get muddled. They aren’t bad, though; in fact, sometimes they might be the only option. But the rules are tighter, and the risks are higher.
IRA-to-IRA rollovers occur when the IRA owner takes possession of the funds. The check is written directly to the individual or deposited into the individual’s account (e.g., a checking or savings account) and the financial organization reports it as a distribution on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The IRA owner then has 60 calendar days to put the money into another IRA, the same IRA, or a qualified retirement plan. The clock starts ticking the day after the IRA owner receives the distribution. If they miss that deadline, the amount cannot be rolled over, and—depending on whether it’s a Traditional or Roth IRA, and relevant facts and circumstances—tax and penalty consequences could result. Plus, IRA owners can only roll over one IRA distribution in a 12-month period—regardless of how many IRAs they have.
There are many circumstances where an IRA owner may want access to her retirement funds on a short-term basis, and a rollover may be the appropriate transaction. Remember that a rollover starts with one distribution; those funds can be rolled back using multiple contributions over the course of 60 days, but an IRA owner cannot roll over more than the distribution amount. The rollover contribution will be reported on Form 5498, IRA Contribution Information. IRA owners don’t have to roll over the entire amount, but whatever amount they decide to keep will be considered a taxable distribution.
Why This Matters
As people retire, money-in-motion events become more frequent. Every job change, every retirement, every individual consolidating accounts creates opportunities for errors.
That’s a lot of potential for IRA owners to make mistakes similar to the one that Dave made. And once clients have a bad experience with an IRA rollover, it doesn’t just affect their wallet. It can damage their trust in financial organizations.
This is where financial organizations can make the difference, not just by processing their transactions, but by proactively steering IRA owners toward the safest option.
Best Practices for Your Organization
The best thing that you can do to help IRA owners is to make sure they understand the difference between a transfer and a rollover. IRA-to-IRA transfers are nonreportable and are not subject to the 60-day deadline or to the one per-12-month rule. If clients want to complete a rollover, make sure they understand the 60-day deadline and the one-per-12-month rule. If done correctly, rollovers will be reportable, but not taxable.
Talk to your clients who request a “rollover” check and clarify their intent before the funds move. You may want to use our example, Dave’s $30,000 mistake, because it may resonate more than a technical explanation.
The bottom line is that transfers and rollovers are two sides of the same coin. They are both designed to keep retirement savings in tax-advantaged accounts. Transfers can be smoother and more risk-free, while rollovers—though they grant short-term access to an IRA’s assets— can sometimes turn into a tax nightmare if clients don’t know the rules.
Educate your clients. Because when it comes to their retirement savings, no one wants to learn the hard way.
