New IRS Interpretation of IRA Rollover Rules

March 27, 2014 12:00 am

Betsey A. Purinton, CFP®

Managing Partner & CIO

The IRS has just announced that it intends to follow a recent Tax Court opinion (Bobrow v. Commissioner, T.C. Memo) regarding IRA rollovers. The changes, which won’t become effective until after January 1, 2015, could have significant tax ramifications for IRA owners who plan to shift their retirement money between IRA accounts. Fortunately, proper planning can help most people avoid extra tax assessments.

First a little background: there are two ways a person can move money between IRAs.

The first is to complete a direct transfer, whereby the IRA owner moves the IRA assets between one trustee and another, such as transferring an IRA at Fidelity directly to an IRA at Pershing. With this method, the IRA owner never uses or controls the money. This type of transfer was not challenged by the Tax Court, and there are no limitations as to how many times IRAs can be subject to direct transfers.

The second way is to complete a rollover. During the rollover process the IRA owner takes a distribution from the IRA and within 60 days moves it into the same IRA or another IRA established for his benefit.  If the owner completes the rollover within 60 days, the individual will not have to report the distribution as income on his tax return.  Currently, IRS publication 590 limits rollovers to one a year for the same IRA. The new rules will limit rollovers to one per 1-year period for all of the owner’s IRAs.

Suppose you have a CD in an IRA at a bank and it matures. Instead of buying a new CD in the same account, you decide to take the money out, either because you can get a higher rate at another bank or because you want to invest it at another company.  Within the 60 days, you roll the cash into a new IRA for your benefit at another institution.

So far so good. But let’s say you try to do the same thing within the next 365 days with another IRA that you have at a totally different bank. The second rollover used to be allowed, because you were dealing with totally different IRAs. Now, after the beginning of next year, your IRAs will no longer be viewed separately. You have one shot at taking money out of your IRAs and putting it back in during any 1-year period.

The penalties for violating the new rules can be stiff and may include:

1.    Reporting of any ineligible distributions as income
2.    A 10% penalty if you are under the age of 59.5 years.
3.    The potential for a 6% excess contribution tax
4. Underpayment and inaccuracy penalties if you are correcting a previous (post 2015) return

Why is this happening? You can make the case that it is simply a new interpretation of existing wording of the tax code. However, it doesn’t help that Bobrow v. Commissioner involved individuals who appeared to be trying to take advantage of the system, by withdrawing money from multiple IRAs on a staggered basis. In other words, the Tax Court and the IRS do not want people to have the ability to repeatedly move money around on a tax-free basis, employing the funds for personal use along the way.

Why is this important? It is easy to forget how long ago you took your last IRA rollover. Or, if you are dealing with several financial institutions, for each bank or advisor to know that the other institution has done.  Therefore, going forward, the best advice is for you to complete trustee to trustee transfers whenever you are moving money from one IRA to another, and if you absolutely must do an IRA rollover, do not complete more than one a year. When there is a readily available way to spare yourself potential taxes and penalties, it is difficult to justify talking on extra risk of doing rollovers.

Disclaimer: The new IRS ruling appears to only affect an individual retirement account or an individual retirement annuity. In addition, there are some exceptions to the rollover rules. When contemplating a rollover, consult with your tax and wealth management professionals before starting the process.

Betsey Purinton, CFP®
is Managing Director and Chief Investment Officer at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at bpurinton@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.