Rollovers: One to a customer

posted 4/24/2014 in Trust

Rollovers: One to a customer

When there’s an unexpected financial emergency of some sort, there may be a strong temptation to borrow from retirement savings to meet it. For example, many 401(k) plans have provisions that allow participants to borrow from their accounts. Another possibility, if the need is very short-term, is to exploit the IRA rollover rules to create the equivalent of a very short-term loan from that account. (Note that actual loans from an IRA are not allowed.)

When an IRA owner wishes to move his or her money to another financial institution, a distribution from the IRA will not be taxable so long as it is rolled into the new IRA within 60 days. The 60-day figure likely was chosen for administrative convenience. What’s more, the money simply could be redeposited in the original IRA and still preserve this tax treatment. However, taxpayers are permitted only one IRA rollover per year.

Recently, a couple tried to tack a series of IRA rollovers together to create a six-month loan for themselves. Husband withdrew $65,064 from his traditional IRA on April 14, 2008, and another $65,064 from his rollover IRA on June 6, 2008. On June 10, 2008, $65,064 was returned to the traditional IRA. Wife withdrew $65,064 from her IRA on July 31, 2008. On August 4, within 60 days of the husband’s June 6 withdrawal, the $65,064 was redeposited in the rollover IRA. Wife made a partial redeposit of $40,000 to her IRA on September 30. The couple treated all of these transactions as nontaxable rollovers, and they reported no taxable IRA distributions.

The plan failed on several fronts, according to the Tax Court. Although the couple assumed that the rollover restrictions apply on a per account basis; instead they apply per taxpayer. The tax code is not ambiguous on the question. So only Husband’s first rollover was tax free; the second was not. Wife is entitled to her own rollover, but here the mistake was more prosaic. One might assume that September 30 is within 60 days of July 31, but it is not. In fact, that is the 61st day, so Wife’s partial redeposit did not reduce the taxes on her withdrawal either. These were premature distributions, subject to the 10% penalty tax. Failure to report the distributions as taxable led to a significant understatement of tax liability, triggering another 20% penalty. All in all, perhaps the “short-term loan” from the IRA wasn’t such a good idea.

Alternate facts. What if a taxpayer wants to consolidate several IRAs into a single account? Does he or she have to spread that consolidation over several years, just moving one account at a time?

No. Account consolidations may be handled as trustee-to-trustee transfers, rather than distributions followed by rollover deposits. If the money is not distributed to the taxpayer, the 60-day rule does not come into play. There is no tax code limit to the number of trustee-to-trustee transfers that a taxpayer may make in a year.

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