Retirement plans are a beneficial way to save money for your future because they allow you to make pre-tax contributions and they provide tax deferred growth on your investments. There are many different types of retirement plans including employer sponsored plans, such as the 401k, 403b, and Simple IRA as well as the very popular, selfdirected Individual Retirement Account (IRA), the Roth IRA, and the SEP IRA. Because these accounts are intended to be used for retirement, there are several IRS rules and regulations which need to be followed in order to reap the benefits and avoid the penalties. In addition, the rules can vary from one type of IRA plan to another. For this article, I am going to focus on the 60-day Rollover Rule (Internal Revenue Code Section 408(d) (3)).
Retirement accounts are required to be held at financial institutions. These institutions are referred to as custodians. The custodian handles the reporting of retirement plan activity, such as contributions and distributions, to the IRS. They also take custody of the assets, process all transactions, maintain records, file required IRS reports, and issues client statements. Great care must be taken if you decide you want to change from one custodian to another. The manner in which this change is made is important to the IRA owner. Penalties and taxes can apply if not handled correctly.
So, what is the 60-day Rollover Rule? In the past, this rule allowed individuals who were changing custodians, to receive a check from their qualified account/IRA made out to them personally. They would then have 60 calendar days from the receipt date to redeposit those funds into another qualified account/IRA, or even back to the same one. It was intended to help individuals who wanted to change the custodian of their retirement account by using the indirect transfer to avoid paying taxes. However, as time passed, a loophole was found and it became a way for investors to take short term ‘loans’ from their IRAs without having to pay taxes or penalties, as long as the money is put back in within the 60-day ‘rollover’ period. If distributed assets are not contributed back within the allotted time, the distribution will be considered a withdrawal and become a taxable event. In addition, if you are under 59 ½ you will also be hit with the 10% early withdrawal penalty.
Because one 60-day rollover was allowed per qualified account, per year, people began setting up multiple IRA accounts, which gave them the ability to take numerous ‘short term loans’ per year. About a year ago there was a court case regarding a tax lawyer who had multiple IRAs. He took a 60-day rollover out of one of his IRAs, then he did a second rollover out of another one of his IRAs to pay back the first distribution, then his wife did a rollover from her IRA and he used that money to pay back his second distribution. The multiple rollovers allowed him to have the money for about 6 months. This type of scenario was by no means what the IRS had intended for the rule. In the end, the tax court ruled in favor of the IRS, basically saying enough is enough and the law was changed. Now, as of January 1, 2015, owners of individual retirement accounts can only do one 60-day rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own. The limit will apply by aggregating all of an individual’s IRAs, including SEP and SIMPLE IRAs, as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit. The one-year period is not a calendar year; it is a rolling 365 days or 12 months from the date of the rollover distribution. If a second 60-day rollover takes place within the one-year period, the distribution will be taxable and subject to a 10% early-withdrawal penalty if the client is under 59 ½. Should an individual attempt a second rollover, the problem cannot be fixed and the IRS does not have the authority to help correct the situation.
This new rule does not apply to direct rollovers or IRA transfers which are the simplest, most seamless way to change a custodian. An account owner will complete documents from a new custodian that authorizes the direct rollover or transfer from their IRA or employer sponsored plan. The new custodian then transmits this authorization for transfer to the former custodian. The transfer is typically completed in a few business days. In the event there are securities that cannot be transferred “in kind,” instructions to liquidate those positions will be included or they will not be transferred. The account owner does not take possession of any proceeds, and if a check is issued it is made payable to the custodian for the benefit of the individual so no reporting to the IRS is required.
If you currently have an old 401k or employer sponsored plan or any other IRA that you would like to consolidate into a self-directed IRA, please give our office a call, 812.232.5822, and we will be happy to help you through the process while avoiding taxes and penalties.
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