The Internal Revenue Service is giving advisors some much needed guidance regarding the ever-challenging issue of rollovers as 2014 draws to a close.
The guidance reflects a change made earlier this year by a tax court ruling that said IRA holders can do only one IRA-to-IRA rollover per year.
IRA guru Ed Slott, who runs IRAHelp.com — and provides countless seminars for advisors to help them grasp the mind-numbing complexities of rollovers — gave ThinkAdvisor on the same day the IRS guidance was released his top-10 list of where advisors make the most mistakes regarding rollovers. “Probably the biggest mistakes are with beneficiary rollovers,” he said, and “that includes children, grandchildren, trusts and charities.”
The IRS clarification that was released in mid-November relates to the change announced in early April regarding how the statutory one-per-year limit applies to rollovers between IRAs.
The change in the application of the one-per-year limit reflects an interpretation by the U.S. Tax Court in a January 2014 decision applying the limit to preclude an individual from making more than one tax-free rollover in any one-year period, even if the rollovers involve different IRAs.
Before 2015, the one-per-year limit applies only on an IRA-by-IRA basis (that is, only to rollovers involving the same IRAs), the IRS explained.
Beginning next year, the limit will apply by aggregating all an individual’s IRAs, effectively treating them as if they were one IRA for purposes of applying the limit, the IRS said.
The new interpretation will apply beginning Jan. 1, 2015, and a distribution from an IRA received during 2014 and properly rolled over (normally within 60 days) to another IRA will have no impact on any distributions or rollovers during 2015 involving any other IRAs owned by the same individual.
“This will give IRA owners a fresh start in 2015 when applying the one-per-year rollover limit to multiple IRAs,” the IRS said.
The IRS went on to explain that “although an eligible IRA distribution received on or after Jan. 1, 2015, and properly rolled over to another IRA will still get tax-free treatment, subsequent distributions from any of the individual’s IRAs (including traditional and Roth IRAs) received within one year after that distribution will not get tax-free rollover treatment.”
The IRS stressed that as its guidance makes clear, “a rollover between an individual’s Roth IRAs will preclude a separate tax-free rollover within the one-year period between the individual’s traditional IRAs, and vice versa.”
Excluded from the one-year limit, however, are Roth conversions (rollovers from traditional IRAs to Roth IRAs), rollovers between qualified plans and IRAs, and trustee-to-trustee transfers—direct transfers of assets from one IRA trustee to another.
Slott said that advisors need to brush up on the scads of different types of rollovers (there are 31; yes, you read that correctly), which each contain their own “set of rules and traps.”
If rollover rules “are not followed, taxes and penalties can be triggered,” Slott said, so it “really is a minefield, which is why advisors need to be better educated on these issues.”
Most advisors, he said, don’t get educated “until [a] problem comes up, and by then it’s often too late to fix it. Most of the rules in this [rollover] area are unforgiving.”
A non-spouse beneficiary cannot do a rollover and this rule, Slott said, “causes the most mistakes,” usually because the beneficiaries generally don’t know this and neither does the advisor.
Slott said the top 10 areas for rollover mistakes advisors make are:
Non-Spouse rollovers, which are not allowed.
Spousal rollovers, including special spousal options.
401(k) rollovers to IRAs (the mistake here is not exploring the five other options before doing the IRA rollover).
After-tax rollovers from plans to IRAs and Roth IRAs (new rules on this; see sidebar).
Roth conversions, which are technically rollovers from IRAs to Roth IRAs.
In-Plan Roth rollovers, i.e., 401(k) to Roth 401(k) conversions.
IRA to IRA rollovers, as well as Roth IRA to Roth IRA rollovers (see the once-per-year rule mentioned above).
Rollovers to any other retirement account (the 60-day rule).
QDRO rollovers in divorce (from plans only) to the ex-spouse as alternate payee.
Rollovers from IRAs back to plans.
Slott’s bottom line takeaway for advisors: “Once IRA or plan money is in motion, it can easily be lost when the tax rules are not followed precisely.”