Managing Your Account
If you’re considering rolling over or transferring an IRA, you may have heard of the “60-day rule.” Some people get confused about what the rule is, and if it applies to their situation. Let’s put the confusion to rest: here’s what you need to know.
60-day rollover rule explained
When you roll over your retirement account from one account to another, you have 60 days to place the funds you took out, or “distributed,” into a qualified IRA or retirement account. Otherwise, you potentially face taxes and a 10-percent penalty if you’re under the age of 59½. This is known as the “60-day rollover” rule.
The IRS only allows this distribution rollover to occur once in a 12-month period across all IRAs you own.
Here’s where people sometimes get confused:
60-day distribution rollover vs. transfers and direct rollovers: what’s the difference?
Some people mistakenly believe the 60-day rule applies to their situation when, in fact, it doesn’t. For example, they think they can only roll over or transfer funds directly from one account to another only once a year, confusing a direct rollover or transfer with the 60-day rollover rule.
When you perform a transfer or direct rollover, you are not taking active receipt of your funds. Therefore, this does not count toward the once-in-a-12-month-period time frame.
Has this rollover rule changed recently?
There have been no changes to the rule, but there has been recent guidance from the IRS. Several years ago, the guidance was that you could perform one of these 60-day rollovers “once a year from each account.” This would allow someone to open several different accounts and take a distribution and return the funds within 60 days, creating a revolving use of tax-privileged funds.
The IRS released updated guidance stating that you can only do this once in a 12-month period across all IRA accounts.
Video: 4 Ways to Fund a Self-Directed IRA
What to know: rules for various types of account movements
• Transfers: No limit, provided they are trustee-to-trustee
• Rollovers: No limit, provided it is a direct rollover
• 60-day distribution rollovers: Only allowed once in a 12-month period across all accounts
• Roth Conversion: No limit providing it is a direct conversion
[Related: Difference between transfers and rollovers]
If you have an inherited IRA, you may not take a distribution and return it in 60 days. You may only perform a trustee-to-trustee transfer.
For more information on the difference between transfers and rollovers, read this explanation.
Want to know more about the process to transfer an account to Equity Trust Company? Request a call from a Senior Account Executive.
Yes. A self-directed IRA gives you the ability to diversify your portfolio with additional investments that are permitted by the IRS, in a tax-free or tax-deferred environment.
You can complete one rollover per 12-month period. The 12-month period begins on the date you receive the funds/assets, not the date the funds/assets were sent to you from your IRA custodian.
If a second distribution is made during the 12-month period it will not be eligible for rollover. This means the distribution is a taxable event and is subject to the 10-percent penalty tax, if applicable. In addition, those funds cannot be validly deposited into your account as a rollover contribution. They will be treated as a regular contribution for the current year, which may result in an excess contribution.
A rollover occurs when you request a distribution from an IRA or a Qualified Retirement Plan and then “roll” the assets into an IRA. There are three types of rollovers: an IRA rollover, a Qualified Retirement Plan rollover, and a Qualified Retirement Plan Direct rollover.
What You Need to Know
- Violating this IRS rule is one of the most expensive mistakes a client can make.
- The rule doesn't apply to rollovers from a 401(k) account or to Roth IRA conversions.
- The simplest way to avoid mistakes is to use trustee-to-trustee transfers between financial institutions.
To say that 2020 and 2021 have presented a planning challenge is an understatement. Now, with the most serious dangers of the pandemic receding into the rearview, many clients might be interested in taking steps to consolidate their retirement accounts and simplify their finances.
That can be trickier than many clients anticipate, especially for clients with multiple IRAs. Violating the “once per year” IRA rollover rule is one of the most expensive mistakes a client can make — and, unlike RMD mistakes, can’t simply be corrected or waived.
Because the IRS can’t waive the client’s violation of the once-per-year rule, it’s especially important to pay close attention to avoid falling into the potential traps that can cause the client to violate the rule and incur significant tax consequences.
What Is the Once-Per-Year IRA Rollover Rule?
Clients can complete nontaxable rollovers between IRAs as long as the funds from the first IRA are deposited into the second IRA within 60 days. However, the client can only do this once in any 12-month period. If the client makes a second rollover within 12 months of the first rollover, the entire amount that was intended for rollover will be deemed distributed in a fully taxable transaction.
The penalties don’t end there, however. If the client isn’t eligible to withdraw funds from the IRA because he or she hasn’t reached age 59 ½, the client can also be subject to the 10% early withdrawal penalty on top of his or her ordinary income tax rates. The rollover can also trigger the 6% tax on excess IRA contributions if the mistake isn’t corrected on time.
The rule applies to all IRAs — including traditional IRAs and Roth IRAs. It does not apply to rollovers between IRAs and employer-sponsored 401(k) plans. The rule also applies to all types of IRAs, so if the client has a SEP IRA, SIMPLE IRA or Roth IRA, the client is limited to one rollover per year across all types of accounts (Roth conversions do not count as rollovers).
The one IRA-to-IRA rollover per year rule applies regardless of how many IRAs the client has. This represents a change from prior thinking, where many believed that taxpayers with multiple IRAs could complete one tax-free rollover per IRA per year.
IRA Rollover Traps to Avoid
It’s important to understand, as an initial matter, that the once-per-year rule is not actually a calendar year rule. It applies on a 12-month basis. The client cannot, therefore, complete one rollover late in 2021 and another early in 2022 without penalty.
Using a rollover to transfer money from one tax-advantaged retirement account to another can be tricky. One thing you must understand is the 60-day rollover rule, which requires you to deposit all your funds into a new individual retirement account (IRA), 401(k), or another qualified retirement account within 60 days.
Most folks see it as a ticking time bomb. However, if you have a need for cash and your retirement funds are your best source, the 60-day rollover rule can be used to your advantage.
- With a direct rollover, funds are transferred straight from one retirement account to another.
- With an indirect rollover, you take possession of funds from one retirement account and personally reinvest the money into another retirement account—or back into the same one.
- The 60-day rollover rule says you must reinvest the money within 60 days to avoid taxes and penalties.
Most rollovers happen without anyone actually touching the money. Say you’ve left your job and want to roll over your 401(k) account into a traditional IRA. You can have your 401(k) plan administrator directly transfer the 401(k) money to the IRA you designate. You can do the same thing with a new 401(k) plan at a new job. This sort of trustee-to-trustee transaction is called a direct rollover. You avoid both taxes and hassle with this option.
You can also receive a check made out in the name of the new 401(k) or the IRA account, which you forward to your new employer’s plan administrator or the financial institution that has custody of your IRA. For most people that option just adds a step, though it’s sometimes necessary if the old plan administrator can’t do the trustee-to-trustee thing. Still, this counts as a direct rollover: Taxes won’t be withheld because technically you never took possession of the funds—the check for them was made out to the account.
In some cases, however, you might want to take actual control of the funds, with the aim of transferring the money to a retirement account yourself. This is called an indirect rollover. You can do it with all or some of the money in your account. The plan administrator or account custodian liquidates the assets and either mails a check made out to you or deposits the funds directly into your personal bank/brokerage account.
The 60-day rollover rule primarily comes into play with indirect rollovers, which the Internal Revenue Service (IRS) actually refers to as 60-day rollovers. You have 60 days from the date you receive an IRA or retirement plan distribution to roll it over to another plan or IRA. If you don’t, the IRS treats your withdrawal as, well, a withdrawal—and if you’re under the age of 59½, an early withdrawal at that. You get socked with income taxes on the entire amount, and if you’re under 59½ you pay a 10% penalty as well.
That’s why most financial and tax advisors recommend direct rollovers—there is less likelihood of delays and mistakes. If the money goes straight to an account or a check’s made out to the account (not you), you have deniability in saying you ever actually took a taxable distribution should the funds not be deposited promptly. Still, even with direct rollovers, you should aim to get the funds transferred within the 60 days.
One other way to get money from your IRA before age 59½ takes advantage of a little-known section of the IRS tax code known as Rule 72(t). It exempts you from the usual withdrawal penalty if you take the funds according to a specific schedule, which lasts for five years or until you reach 59½, whichever is longer.
The 60-day rollover rule essentially allows you to take a short-term loan from an IRA or a 401(k).
Why would you ever do an indirect rollover, given the ticking clock? Perhaps you need to detour the funds on their trip from retirement account to retirement account. The IRS rules say you have 60 days to deposit to another 401(k) or IRA—or to re-deposit it to the same account. This latter provision basically gives you the option to take a short-term loan from your account.
It's a strategy that primarily works with IRAs, as many—though not all—401(k) plans often allow you to borrow funds anyway, paying yourself back over time with interest. Either way, the 60-day rollover rule can be a convenient way to borrow money from a normally untouchable retirement account on a short-term basis, interest-free.
Taking temporary control of your retirement funds is simple enough. Have the administrator or custodian cut you a check. Do with it what you will. As long as you redeposit the money within 60 days after you receive it, it will be treated just like an indirect rollover.
However, there is a tax complication. When your 401(k) plan administrator or your IRA custodian writes you a check, by law they have to automatically withhold a certain amount in taxes, usually 20% of the total. So you won’t get as much as you may have figured on.
To add insult to injury, you need to make up the amount withheld—the funds you didn’t actually get—when you redeposit the money if you want to avoid paying taxes.
If you take a $10,000 distribution from your IRA, your custodian will withhold taxes—say, $2,000. If you deposit an $8,000 check within 60 days back into the IRA, you’ll owe taxes on the $2,000 withheld. If you make up the $2,000 from other sources of income and redeposit the entire $10,000, you won’t owe taxes.
There are three tax-reporting scenarios. Continuing with the $10,000 rollover example above:
- If you redeposit the entire amount you took out, including making up the $2,000 in the taxes withheld, and you meet the 60-day limit, you can report the rollover as a nontaxable rollover.
- If you redeposit the $8,000 you took out but not the $2,000 taxes withheld, you must report the $2,000 as taxable income, the $8,000 as a nontaxable rollover, and the $2,000 as taxes paid, plus the 10% penalty.
- If you fail to redeposit any of the money within 60 days, you should report the entire $10,000 as taxable income and $2,000 as taxes paid. If you’re under 59½, you’ll also report and pay the additional 10% penalty, unless you qualify for an exception.
Obviously, you should only use this strategy if you’re 100% certain you’ll be able to redeposit the money within the 60-day window. Also, bear in mind that during any 12-month period, you’re allowed only one indirect IRA rollover (even if you have several IRAs). However, direct rollovers and trustee-to-trustee transfers between IRAs aren’t limited to one per year, nor are rollovers from traditional to Roth IRAs.
Rebecca Dawson
President, Dawson Capital, Los Angeles, Calif.
If you withdraw funds from a traditional IRA, you have 60 days to return the funds or you will be taxed. If you are under 59½ you will also pay a 10% penalty, unless you qualify for an early withdrawal under these scenarios:
- After IRA owner reaches 59½
- Death
- Total and permanent disability
- Qualified higher-education expenses
- First time home buyers up to $10,000
- Amount of unreimbursed medical expenses
- Health insurance premiums paid while unemployed
- Certain distributions to qualified military reservists called to duty
- In-plan Roth IRA rollovers or eligible distributions contributed to another retirement plan within 60 days
There's one other option: A little known section of the IRS tax code allows substantially equal periodic payments annually before 59½. It stipulates that you take money out of your IRA for five years or until age 59½, whichever is longer.