Clear as Mud



By:  Mark Stinson, CPA, CFP ®, MBA | Director of Planning

The IRS has issued new “guidance” for IRA rollover rules, and investors are confused.

Here is what the IRS website states:

“Beginning as early as January 1, 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own (Announcement 2014- 15). You can, however, continue to make as many trustee-to-trustee transfers between IRAs as you want. You can also make as many rollovers from traditional IRAs to Roth IRAs (“conversions”) as you want.”

As my father says, “Clear as mud!” Financial planners understand what the IRS is saying—normal people, however, do not.

What exactly are rollovers and trustee-to-trustee transfers? According to Investopedia, a rollover is when an investor:

  1. Reinvests funds from a mature security into a new issue of the same or a similar security.
  2. Transfer the holdings at one retirement plan to another without suffering tax consequences.

Investopedia does not have a definition of “trustee-to-trustee  transfer.” However, it does define a direct transfer as a “transfer of assets from one type of tax-deferred retirement plan or account to another.  Direct transfers are not considered to be distributions and are therefore not taxable as income or subject to any penalties for early  distribution.”

Guess what? Neither of those definitions fits the IRS definition. Confused? Then you are normal. Here is what is going on.

There are two ways to transfer money from one IRA to another IRA: a rollover or a trustee-to-trustee transfer.

ROLLOVER

According to the IRS, the proper definition of a rollover is when an investor receives  a check made out to him or her from an IRA and deposits the proceeds into another IRA within 60 days. This is also referred to as a “60-day rollover.” The key feature of a rollover is that the investor takes possession of the funds—either by check or wire transfer.

If the investor does not deposit the check into an IRA within 60 days, then the investor is deemed to have taken a withdrawal from the IRA and must pay ordinary income tax on the amount of the distribution. If the investor is younger than 59 ½, then the investor will also pay a 10 percent early withdrawal penalty.

TRUSTEE-TO-TRUSTEE  TRANSFER

The second way to transfer money is a trustee-to-trustee   transfer—sometimes referred to as a “direct transfer” (correct) or “direct rollover” (incorrect). In a trustee-to-trustee transfer, the investor does not take possession of the funds.  Instead, transfer checks are made out to the receiving custodian (for example, TD Ameritrade, “For Benefit Of (FBO) Happy Retiree”). Alternatively, the funds are wired from one existing IRA to another IRA. The key is that the investor never has possession of the funds. The investor can make an unlimited number of trustee-to-trustee transfers.

Investors should always use the trustee-to-trustee transfer to move IRA funds because:

  1. The once-a-year rule does not apply.
  2. There is no 60-day deadline.
  3. There is on taxes withheld on the transfer.

WHAT IS THE BIG DEAL?

IRS Publication 590, “Individual Retirement Arrangements (IRAs),” states that investors can make one rollover per year in each IRA that they own. Now, under the new guidance, investors can only make one roll- over, no matter how many IRAs they have.

Apparently, what is printed in Publication 590 is a proposed regulation and not an approved regulation. Therefore, the IRS has issued guidance that contradicts a proposed regulation. Therefore, we still do not have an approved regulation. Still confused (normal)…?

The IRS has issued new guidance due to abuse of the 60-day rule—investors have been withdrawing funds from IRAs for non-retirement purposes with the expectation that they will redeposit those funds within 60 days. For example, funds are withdrawn as a bridge loan between the purchase of a new house and the settlement on the old house. Sometimes the withdrawal is purely speculative, though, like lottery tickets.

Sometimes, as you might guess, things don’t go as expected, and the investor is unable to redeposit the withdrawn funds within 60 days, resulting in the taxes and penalties noted above.

THE FINE PRINT

In addition, under the new guidance, any additional rollovers after the  first could be deemed “excess contributions,” which incur a 6-percent excess contribution penalty for each year the excess contribution remains in the IRA.

This new guidance only applies to IRA-to-IRA or Roth IRA-to-Roth IRA transfers. It would not apply to a rollover to or from an employer-sponsored retirement plan. The IRS will not enforce this guidance retroactively.

BOTTOM LINE

Never use rollovers and only use trustee-to-trustee transfers.

If you have questions about IRA rollovers or financial planning in general, you can contact Mark Stinson at 410-461-3900 or mstinson@bwfa.com.