Over the past few months, there has been a lot of talk about the once-per-year IRA rule… and with good reason. Back in late January, the Tax Court dropped a bombshell of a decision, reshaping the once-per-year rollover rule as we — and, as it turned out, the IRS — knew it. Since then, advisors and clients have been asking many questions. Here are some of the most commonly asked questions you need to be aware of, along with their answers, so that you can help clients successfully navigate the new rule.
What exactly is the once-per-year rollover rule?
An IRA owner can only roll over one IRA distribution within a one-year period. The one-year period is 365 days, not a calendar year, and starts on the day the IRA owner receives the distribution. The rule only applies to IRA-to-IRA and to Roth IRA-to-Roth IRA 60-day rollovers.
What happens if the once-per-year rollover rule is violated?
If clients attempt to make more than one IRA-to-IRA or Roth IRA-to-Roth IRA rollover within a 365-day period, the tax consequences could be severe. The second (third, fourth, etc.) “rollover” within the 365-day period will be considered a distribution which, for traditional IRAs, will generally be subject to income tax and, if the IRA owner is under 59½, the 10 percent penalty. For Roth IRAs, the distribution may be subject to income tax and/or the 10 percent penalty, depending on what “type” of Roth money is deemed to have been distributed and whether or not the distribution is a qualified distribution.
As if that’s not bad enough, since only one distribution is eligible for rollover within a 365-day period, subsequent distributions erroneously “rolled over” during that time frame could result in excess contributions in the receiving account, subject to the 6 percent excess contribution penalty for each year they remain in the account.
What’s all this news I hear about changes to the once-per-year rollover rule?
Earlier in 2014, the Tax Court handed down a landmark decision, in which it ruled that the once-per-year rollover rule applies in aggregate to all of a client’s IRAs. Previous interpretations of the rule, including the IRS’ own guidance in Publication 590 (the IRS Publication that deals with IRAs), treated the rule as applying on an account by account basis. Since the Bobrow decision was released, the IRS has provided further guidance on the issue and how it will treat such transactions going forward. What if my client has already made multiple 60-day rollovers from different IRAs within the same one-year period?
They are ok…for now. The IRS has agreed to follow the Bobrow decision and the Tax Court’s interpretation of the rule, but for a variety of reasons, including the administrative challenges it poses, the earliest it will do so is 2015. You should probably warn clients not to make similar transactions in the future, but they can rest easy knowing that any past rollovers won’t be disqualified by IRS, so long as they were validly completed under the interpretation of the rules in effect at the time.
Do all rollovers count towards the once-per-year rollover rule?
No. There are many ways in which a client can move retirement money that are not impacted by the Bobrow decision and the resulting changes to the once-per-year rollover rule. These ways include:
1. Trustee-to-Trustee IRA Transfers – This is the best way for IRA money to be moved from one IRA to another. Technically, an IRA trustee-to-trustee transfer is not a rollover, although the term “direct rollover” is also often used. When such a transfer is made, funds go directly from one custodian to another without the account owner having an opportunity to use the funds while they are out of the IRA.
When money is moved this way, there is no 60-day deadline and the once-per-year rule does not apply. IRA owners may make as many direct transfers as they like, and at any time. Recent IRS guidance confirmed this, saying “These actions by the IRS will not affect the ability of an IRA owner to transfer funds from one IRA trustee directly to another, because such a transfer is not a rollover and, therefore, is not subject to the one-rollover-per-year limitation.”
2. Plan-to-IRA Rollovers – The once-per-year rollover rule is an IRA-to-IRA and Roth IRA-to-Roth IRA rule. So, if a client makes a rollover that isn’t between two IRAs or two Roth IRAs, it does not count as a rollover for purposes of the once-per-year rule. For instance, if a client rolls over money from a 401(k) to an IRA on January 10th of year one and then rolls that money via a 60-day rollover to another IRA on March 1st of the same year, the once-per-year rule has not been violated.
3. IRA-to-Plan Rollovers – Similar to the plan-to-IRA exclusion outlined above, IRA-to-plan rollovers also don’t count as rollovers for purposes of the once-per-year rollover rule. Although the tax code allows pre-tax IRA money to be rolled into a plan, the plan must also allow for such a transaction before a client can move forward.
4. Roth IRA Conversions – If money is converted from an IRA or employer plan to a Roth IRA, either directly, or indirectly via a 60-day rollover, the conversion — which is technically a rollover — does not count as a rollover for purposes of the once-per year rule. Recharacterizations also don’t count.
Will my client be able to do one 60-day IRA-to-IRA rollover and one 60-day Roth IRA-to-Roth IRA rollover in the same one-year period?
The IRS has not addressed this issue in formal guidance, but based on its Employee Plans News Issue 2014-5, released on March 27, 2014, it appears the IRS will apply the once-per-year rollover rule separately to IRA rollovers and to Roth IRA rollovers. After describing the rule in reference to traditional IRAs, the document says, “A similar limitation will apply to rollovers between Roth IRAs.”