The rule about how many IRA-to-IRA “rollovers” a taxpayer can make in a single year has changed and taxpayers should be aware of it to avoid unnecessary taxes and penalties.
A rollover for our purposes here means moving funds from one IRA to another. The longstanding rule has been that taxpayers may roll over multiple IRAs in a single year, and the Internal Revenue Service had interpreted the limitation of one rollover a year to apply separately to each IRA a taxpayer may own. So the taxpayer could roll over IRA A in February, IRA B in May and IRA C in October without the rollover being treated (and taxed) as an IRA distribution.
In the case of Bobrow v. Commissioner earlier this year (2014), the U.S. Tax Court overturned this longstanding IRA interpretation, instead ruling that a taxpayer may roll over only a single IRA each year. Taxpayers (and their advisors) also need to understand that the year is not a calendar year, but any 365-day period. So if the taxpayer rolls over IRA A on February 1st, she cannot roll over IRA B until February 1st of the following year.
To fully understand what this means, the taxpayer needs to know the difference between a "rollover" and "trustee-to-trustee" transfers of IRAs. A rollover occurs when the taxpayer withdraws funds from her IRA and deposits them into a new or different IRA within 60 days of the withdrawal.
The taxpayer may, however, move as many IRAs as she chooses by having them transferred from institution (or "trustee") to institution. In other words, rather than withdrawing the funds and depositing them into a new IRA within 60 days, the taxpayer directs Charles Schwab to move the IRA funds to a new IRA account at Fidelity. She can do this as often as she would like.
Given that trustee-to-trustee transfers are unrestricted, it would seem that this new limitation is not much of an impediment for taxpayers. And it shouldn't be. However, taxpayers often withdraw funds from retirement accounts – perhaps because they need cash for a short time -- not knowing the consequences. They can be protected from having to pay taxes on the withdrawals if they deposit the funds in a new account or back into the same account within 60 days. Now, however, if they withdraw funds from more than one account, they will have to choose which one to protect -- presumably the largest.
The other reason a taxpayer may prefer a rollover to a trustee-to-trustee transfer is that it can be a lot easier to implement. Financial institutions don't always make it easy to transfer funds to a competitor. They may require a lot of documentation or simply be slow to implement the order.
The trap for the unwary, of course, is that many taxpayers know the old rule permitting multiple rollovers every year and are unaware that this rule has changed.
For a MarketWatch article on "How to Beat the New IRA Rollover Rules," click here.
For more on withdrawing money from retirement accounts, click here.