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, but others are referred to as trustee-to-trustee transfers.
Right now you're probably thinking, “Does it really matter?” The answer is, “Yes, it absolutely does.” There is a very big distinction between the two, and getting it wrong could cost you a small fortune in taxes.
A few years back, the rules 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 — which is made out to you &mdash: 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 “roll it over” 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 meet 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 time limit, it could still be taxable … if it’s not the only rollover you did in the last 12 months. That’s because in 2015 the rules changed to limit 60-day rollovers to one per year. Also, keep in mind that it is not a calendar year but once every 365 days. Previous to the rule change, you were able to do multiple 60-day IRA rollovers.
How the Once-a-Year Rollover Rule Works
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 made within the 60-day window. Why? Because you had already done 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 an exception will not be granted for making more than one rollover per year. It’s important to note that the once-per-year rule only applies to rollovers of traditional and Roth IRAs, not to rolling over funds from employer-sponsored plans to IRAs (such as when you leave a job and need to move your money out of your 401(k) and into an IRA) or to conversions of money from traditional IRAs to Roth IRAs.
Consider a Trustee-to-Trustee Transfer Instead
Instead of taking the funds out of the IRA and then redepositing them into another IRA, you should request that they be sent directly to the new IRA via a trustee-to-trustee transfer. This avoids the possibility of violating the 60-day rule, and you are allowed to do an unlimited number of trustee-to-trustee transfers in any given year.
Some things to keep in mind when you execute a trustee-to-trustee transfer:
- Many trustee-to-trustee transfers are processed electronically and require a transfer of assets form. If the sending company is unable to process a transfer this way, they will send a check to the new IRA. The check should be made payable to the new trustee for your benefit, e.g. Sample Investment Company FBO John Smith.
- Also, the custodian may send the check to you and not to the new investment company. If this happens, make sure you forward the check directly as is to the new investment company.
Trustee-to-trustee transfers help you avoid another issue besides the 60-day time limit and the once-a-year rule: required tax withholding. 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, do a trustee-to-trustee transfer instead. Make sure you have the funds sent directly from the plan to an IRA via direct rollover. As we’ve noted, 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.
Taking these steps 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. 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 adviser with regard to your individual situation.
T. Eric Reich, President of Reich Asset Management, LLC (opens in new tab), is a Certified Financial Planner™ professional, holds his Certified Investment Management Analyst certification, and holds Chartered Life Underwriter® and Chartered Financial Consultant® designations.
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