Most investors have at least one IRA, or individual retirement account. If you’re not familiar with IRA’s, check out our quick guide to IRA and Roth IRA accounts here. While most people have an IRA, they don’t always keep that IRA in the same place forever.
Perhaps fees and trade costs are lower at custodian B compared to custodian A. Who wouldn’t want to save fees and expenses? Or maybe certain investments are available at custodian B, and custodian A can’t accommodate them.
It could be that the reporting, technology, or online access is superior at custodian B. Or perhaps custodian B has better customer service. You might even feel they have the best financial advisors (click to view our financial planning practice).
For a variety of reasons, IRA’s move from one custodian to another from time to time. Most IRA’s transfer from custodian to custodian seamlessly. Sometimes it’s not so easy however, and you must take a distribution from your IRA, then deposit it into the new custodian.
Enter the 60 day IRA rollover rules.
What is a 60 day IRA rollover?
Since not every custodian can transfer directly to another, the IRS has a provision for you to handle the transfer yourself. This is called a “60 day rollover”.
An IRA rollover is far superior to the alternative – cashing the IRA out! If you don’t roll the IRA, into another IRA you will be subject to ordinary income taxes and potentially a 10% penalty if the distribution is prior to age 59 and 1/2. Besides, you do want to save for retirement right?
Clearly, rolling over your IRA into another one is the optimal solution. Your hard earned investment will continue to grow tax deferred until your retirement when distributions become taxable (unless it’s a Roth IRA).
The 60 day IRA rollover rule only applies when the current custodian sends you a check directly. This is technically an IRA distribution, in which taxes and potential penalties would normally apply. The “rollover” part into the new IRA at custodian #2 is what avoids taxes and penalties.
Keep in mind, you’re not required to rollover the entire IRA distribution. You can rollover an amount less (but never more for obvious reasons). Whatever amount is NOT rolled over becomes subject to taxes and penalties however.
Distributions from a 401k or other retirement plan
When you terminate employment, you have a choice to make with how to handle your 401k (or 403b, 457 plan, etc.). Some plans allow you to leave the funds in the plan indefinitely. Other plans require you remove your funds within a specified time period.
Typically, removing your 401k plan funds is fairly simple. Your 401k plan sends you rollover paperwork which you complete and return. Sometimes, they even take these instructions verbally over the phone.
In other cases, the 401k administrator will send a check payable to you. You then have 60 days to roll (deposit) that check over into a qualified IRA or other company sponsored retirement plan.
If the old 401k plan administrator does send you a check directly, they’ll withhold 20% for federal income tax. This is where the 60 day IRA rollover gets tricky!
If you intend on rolling over your funds into an IRA and have informed the old 401k administrator, they should make the check payable to the new custodian for the benefit of your IRA. In this case, they do not withhold the mandatory 20% for federal taxes.
The 20% tax withholding creates a problem!
Recently we had a client bring us a rollover check from his old 457 retirement plan. We’ll call him “John”.
The plan administrator had made the check payable directly to him, not a new IRA custodian. They also withheld the mandatory 20% for federal income taxes.
Using round numbers, his check was for $80,000. He also received notice that $20,000 was sent to the IRS on his behalf. How nice of them!
This was highly frustrating for John. His check for $80,000 wasn’t the full balance of his plan. Rolling over less than the $100,000 means the shortfall is subject to taxes and potentially a 10% penalty.
Since John isn’t age 59 and 1/2 yet, the 10% penalty and ordinary income taxes applies to the entire $100,000. John’s a doctor, and suffice to say his income tax rate is towards the top brackets!
The easy part is rolling over his $80,000 into an IRA. John simply endorses the check to his new custodian referencing his IRA account number. The harder part is making the entire $100,000 account balance “whole” in the IRA, because they withheld $20,000 for taxes.
John intends on rolling over the $80,000. Since it’s not the full $100,000, he would lose $2,000 (the 10% penalty on the $20,000 shortfall), AND ordinary income taxes of roughly $6,000. That’s 40% he’d lose in taxes! Stop the insanity!
To fix the problem, John MUST roll the entire $100,000 into the new IRA custodian. He could go ask the IRS for his $20,000 back, but he won’t get very far with that!
John had to write a personal check for $20,000 to the new custodian. Add that to the $80,000, and John’s new custodian receives the full $100,000 rollover. No taxes or penalties are owed, and voila, problem solved!
While John is out $20,000, it’s only for the moment. He’ll get that back when he files his tax return.
The 60 day IRA rollover rules
It’s important to note, 60 days means 60 days! It’s possible the IRS may allow an exception to the 60 day rule, but these exceptions are hard to come by. Why risk it?
The IRS also imposes limits on how many times you can use the 60 day IRA rollover provision. No matter how many IRA’s you own, you can only use this provision once in a 12 month period.
For example, if you have done a 60 day IRA rollover within the last 365 days, you cannot do another 60 day IRA rollover. Or if you do a 60 day IRA rollover today, you cannot do another one for 365 days.
IRA’s, for tax purposes, are treated as aggregate by the IRS. You can have 20 IRA’s and the IRS looks at them like one IRA. Therefore, it doesn’t matter how many IRA’s you have, you can do one 60 day rollover per 365 day period!
Doing more than one 60 day IRA rollover may expose you to taxes and penalties. Additionally, the amounts which should not have been rolled over are deemed an excess contribution. Excess contributions are subject to a 6% per year tax for as long as the amounts remain in the IRA.
Remember, this ONLY applies to rollovers, not transfers
The 60 day IRA rollover rule applies when you effectively take an IRA distribution and put it back into an IRA within 60 days. This rule does NOT apply to:
- trustee to trustee tranfsers
- checks you may receive that aren’t made out to you, but rather to the new IRA custodian for the benefit of you
In other words, you want to avoid receiving a check for your IRA or retirement account in your name only. This is exactly what the 60 day rollover rule applies to.
Using the 60 day IRA rollover as a short term loan
A few years back we had a client – let’s call him Ted – move out of state. He had a house to buy in Tennessee, and a house to sell here in Las Vegas.
Juggling the finances of his move wasn’t easy. Ted didn’t want to borrow money to buy his Tennessee home, but his house sale here wasn’t going to close in time to pay for the new house in Tennessee. What to do?
After considering short term loans, we looked at borrowing from his taxable investment account on margin. This seemed like a great way to bridge the short term cash crunch gap!
The problem with using margin as a loan is the interest charged. Granted, it wasn’t for a long period of time, but it’s still interest owed to the investment custodian. The rate at that time was about 6% on the amount.
Rather than take the margin loan, Ted took a distribution from his IRA. We wired the funds to his account, and he used them for a down payment on his new home. Shortly thereafter, the sale of his Las Vegas home closed and his proceeds were deposited into his checking account.
To complete the 60 day IRA rollover, Ted put the entire amount of the original distribution BACK into his original IRA (it could go to one of his other IRA’s as well). We did this on day 50, well in time to make the 60 day limit.
60 Day IRA rollover rules in summary
You should rarely need to effect a 60 day IRA rollover. The overwhelming majority of custodians can transfer directly to another, avoiding this rule altogether.
If for some reason you do need to execute a 60 day IRA rollover, please pay special attention to the calendar. The IRS is not very forgiving. Additionally, there is NO EXCUSE for executing more than one IRA rollover within a 365 day period.