A new rule regarding IRA rollovers that took effect in January has put a damper on some folks’ saving strategy.
The rules allow a taxpayer to withdraw IRA assets from a traditional or Roth IRA and redeposit the funds into a similar account within 60 days without owing taxes or being subject to penalties.
However, in the case of Bobrow v. Commissioner of the Internal Revenue, the court determined that the taxpayer can only complete one rollover per 12 month period. Bobrow, a veteran tax attorney who was arguing his own case, contended that IRS publication 590 indicated that taxpayers can do one rollover in a 12 month period per IRA; meaning a taxpayer could rollover multiple IRAs during a 12 month period, as long as they are separate accounts.
"Mr. Bobrow was taking a sum of about $50,000-$60,000 per 59 days and using it as a free loan, for some reason the final time he did this, it was with his spouse’s account, and it didn’t process until 61 days, this was a default situation, and when explored further, it was deemed that his continual habit of rolling over like this was not in the spirit of the rules," explains Matthew Hague, principal of Guide Wealth Management. "The new rule was designed to stop what was perceived to be an abuse of the 60 day rule, where you could withdraw (and have access to) funds from one IRA and hold this for 60 days prior to assigning it to a new IRA."
So blame Bobrow. Some people are none too happy. Those who have several IRA CDs from different banks and credit unions to maximize their interest rates may find it harder to transfer to other IRA CDs at other institutions, causing them to miss out on good IRA CD deals.
To sort out any confusion, direct trustee to trustee transfers remain limitless. "If you wanted to rollover from Fidelity to Vanguard directly, without touching the money, you can do that without being subject to the rules. It only applies if you want your old custodian, say Fidelity, to send you the cash and you use it for 60 days before sending it to the new custodian, Vanguard," explains Hague.
What’s at stake?
CDs are suddenly tricky. The biggest concern area, says Jamie Hopkins, a professor of retirement and associate professor of taxation at The American College is CDs. "CDs are the riskier investments in an IRA now because a lot of banks have automated the CD maturity process for IRA accounts and pay out the mature CD directly to the IRA owner."
In the past, the owner could roll it over within 60 days to a new IRA or the same IRA without issue. "If you do this twice in a year, then one of those mature CDs will not be able to go back into your IRA. This could cause you to lose the tax benefits of the IRA, as you will owe taxes today and won’t be able to get that money back into the IRA for retirement. Failing to pay attention to this rule could cause you to lose a large portion of your IRA to taxes and lose the ability for future tax deferred investment growth inside of your IRA."
"If Mrs. Taxpayer wants to consolidate her five CD IRAs into one IRA and she cashes the CDs and has checks issued to her and then re deposits them, this would violate the rollover rule. All of those excess transfers would be 100% taxable within the year and it will catch many people off guard and require a huge tax liability come next April," says Pat Simasko, an elder law attorney and founder of Simasko Law.
The most important takeaway under the new rule, and potential trap for unsuspecting savers, is that a second rollover cannot be reversed, says Thomas Walsh, an investment analyst with Palisades Hudson Financial Group. IRAs have a lot of rules, but if you make a mistake, most of them can be reversed. For example, excess IRA contributions or mistaken IRA conversions can be reversed, and penalties on missing a required minimum distribution can be waived if you show reasonable cause, he says.
However, once the check is issued for a second rollover within a 12 month period, there’s no clear way to put things back the way they were. "This may be addressed by the IRS in the future, but for now, a second rollover within 12 months would mean the entire rollover amount becomes taxable, and could also be subject to penalties if you are under age 59 ½."
Is there a silver lining in this dark cloud? "In many ways, limiting to direct transfers reduces the risk of human error, like the one where Bobrow didn’t manage to complete his final rollover within the 60 day window," says Hague.
Ryder Taff, portfolio manager of New Perspectives sees an upside, "Some people take money out just to use for every day expenses, which is very harmful for their financial plans. This rule should cut back on that bad practice."