When a client retires or decides to move money from a company plan to an IRA or wants to change from one IRA to another IRA, this is often referred to as a rollover. Some of these transactions are in fact rollovers and others are referred to as trustee to trustee transfers. Right now you’re probably thinking, “Does it really matter?” The answer is “yes.” There is a very big distinction between the two and getting them wrong could cost you a small fortune in taxes.
A few years back, the rules were changed regarding what is known as a 60-day rollover. A 60-day rollover is when you close or take a distribution from one IRA, deposit the check into your bank account, and then subsequently deposit those funds into a different IRA. The rules state that you have 60 days from the time you receive the check to redeposit or “rollover” it back into the new IRA. If you complete the transaction in 60 days, then there is no tax consequence to making the rollover. If you do not make the 60 day time limit, then all of the funds are now taxable to you as income and can be subject to the 10% penalty if you’re under age 59½. This is obviously a nightmare scenario.
Here is where it gets even trickier. Even if you do redeposit the funds within the 60 day limit, it could still be taxable under the new rules because the change in the rules now limits 60 day rollovers to 1 per year. It is not a calendar year but once every 365 days. Previous to the new rule, you were able to do multiple 60-day IRA rollovers.
Let’s look at an example of this part of the rule. Let’s say you have multiple IRA CDs at a bank. Now that interest rates are down, you want to move them elsewhere. The first CD is for $1,000, and when it matures, you take the funds out and redeposit them into a new IRA within the 60 day window. Eleven months later, you have a second CD come due and you decide to do the same thing. This CD was for $100,000, and you also redeposit it within the 60 day window. No problem right? Wrong! The entire $100,000 rollover is subject to tax regardless of the fact that it was within the 60 day window. Why? Because you already did your one rollover for the year. Not only is it taxable but when added to your other income, it could move you into a higher tax bracket, which applies to all of your income, not just the distribution. This transaction cannot be reversed, and there are no exceptions. There are instances where missing the 60-day window can be granted an exception, but it will not be granted for more than one per year. It’s important to note that the one time per year rule only applies to IRAs not rolling over funds from employer sponsored plans to IRAs.
Instead of taking the funds out of the IRA and then redepositing to another IRA, you should request that they be sent directly via trustee to trustee transfer. This avoids the 60 day rule, and you are allowed to do an unlimited number of trustee to trustee transfers in any given year.
If you do a 60 day rollover from an employer sponsored plan, the company is required to withhold 20% in taxes unless it goes directly to an IRA or another company plan. That’s not to say that the tax you owe is 20%, it is simply the amount they are required to withhold. Your tax could be higher or lower depending on your tax bracket. To avoid that withholding requirement, make sure you have the funds sent directly from the plan to an IRA via direct rollover. Some plan sponsors will only mail the check to your address of record. In which case, you will need to forward that check directly to the new plan or IRA. Therefore, you should always have the check made payable to the new custodian (company that holds the IRA), and never to you. This will avoid all of the issues related to 60-day windows or tax withholdings etc. and may end up saving you a lot of taxes and frustration.
Before rolling assets over from a qualified plan, you should consider various factors. These factors include but are not limited to the following: investment choices, fees and expenses, services provided by new option, penalty-free withdrawals, required minimum distributions and tax considerations. Speak to a tax professional about your individual situation before taking any action.
T. Eric Reich, CIMA, CFP, CLU, ChFC is president and founder of Reich Asset Management and can be reached at 609-486-5073 or firstname.lastname@example.org.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.