Rollover Rules You Need to Know

By: Lori Eason, CFP(R)

In my line of work, I am often asked about IRA rollovers.  Most commonly, clients have a 401k with a previous employer and are wondering what steps they need to take to remove their funds from the plan.  Starting in 2015, the IRS now follows a stricter interpretation of the 60-day IRA rollover rule.  I wanted to shed some light on this rule and what the changes mean for investors.

First off, there are two ways to move IRA money from one IRA to another IRA: indirectly and directly.  With indirect transfers, also known as 60-day rollovers, clients receive a check from their IRA made out to them.  They then have 60 days to redeposit the funds to another IRA and you can only have one of these per 12-month period.  The second way is a direct transfer, also known as a trustee to trustee transfer.  This is when funds move from one IRA to another without the client touching the money.  For example, if a check is the method of payment, the check is written by one custodian out to another custodian, i.e. Fidelity writes a check to Charles Schwab and Co.  This is always our recommended method of rollover and this method is not subject to the once-per-year rule.

 

Ever since IRAs have existed, there has been an IRS rule in place that allows IRA distributions to be rolled over within 60 days to avoid taxation.  Under the original rule, there could be one indirect IRA rollover per year, and the IRS interpreted this once-per-year rule to apply on an IRA-by-IRA basis.  Beginning in 2015, you can only make one indirect rollover form an IRA to another IRA in any 12-month period, regardless of the number of IRAs you own.

You may be wondering why the IRS decided to limit indirect rollovers to one per year.  I’m sure you won’t be surprised to find they did so because people figured out a way to abuse the system.  It is possible to use the rollover funds as a personal short-term loan, as long as the rollover contribution is made within 60 days.  Under the previous interpretation, an individual with several IRAs could potentially take a series of rollovers, allowing for an extended period of personal loans much longer than the 60 day period. 

This issue surfaced as a result of the recent ruling in Bobrow v. Commissioner.  Alvan Bobrow, a tax attorney, engaged in a series of sequential rollovers from separate IRAs to form an extended loan strategy.  His strategy involved two of his own IRAs and one of his wife’s.  He actually made a mistake and his final rollover took place after 61 days and was $25k short.  He claimed he had made a timely request and that he had requested the full $65k amount, but couldn’t produce any evidence for either.  Since the last rollover was not complete, it was reported as being partially taxable, but Bobrow disputed it.  I’m not sure which was the dumber move, the original “mistake” or disputing it which is what ultimately drew the IRS’ attention.  He could have just paid his tax bill and moved on.  As a tax attorney, he chose to represent himself in Tax Court.  The Tax Court ended up not only supporting the IRS’ decision, but also declared that since IRAs are aggregated together for income tax purposes, that aggregation should also apply for the once-per-year rollover rule as well. 

There are hefty penalties associated with violating the once-per-year rollover rule.  A second rollover made within a year could cause a taxable distribution plus a 10% penalty if the individual is under the age of 59 ½.  Also, this rollover will be considered an excess contribution subject to a 6% penalty for every year the ineligible rollover funds remain in the account.  It’s important to note that the year is a 12-month rolling period starting with the date of the distribution, not the calendar year.

Although 60-day rollovers are now riskier than in the past, these types of rollovers are easy to avoid by just sticking with direct, trustee to trustee rollovers, which is what we have always recommended.  There is no limit on the number of direct rollovers you can make in a year.  Keep in mind that it’s rarely a good idea to leave funds in a previous employer’s 401k.  While 401ks are a great benefit while you are employed as you can take advantage of salary deferrals and employer matching, they come with a very limited list of investment choices and generally high administrative expenses that are hidden within the funds.  When you’re no longer receiving the employee benefits, it’s time to roll the account over to an IRA.  Feel free to contact me if you’d like guidance on handling a 401k left behind with a former employer.

Second Quarter 2015 Commentary

Breaking News From 2010

Some things just never seem to change.  The recent weeks of volatility that have given us triple digit moves in the Dow Industrial Average have been exclusively driven by worries over Greek debt and the cohesion of the European monetary union.  That last sentence could have lead off our market commentary in 2009, 2010, 2011 or 2014.  Not only has Greece not dealt with their systemic deficit problems, but the EU can’t seem to come to terms with the fact that Greece won’t get its fiscal house in order. 

The recent stock market downturn in the U.S has been in response/sympathy to the broad market declines in Europe.  Euro zone markets have experienced sharp declines as the European Central Bank and IMF have been unsuccessful at negotiating repayment terms for the outstanding Greek debt.  Greece was due to make a substantial loan payment ($1.73b) to the IMF at the end of June, but of course didn’t have the funds necessary to fulfill that obligation.   In addition, Greece is running out of cash to meet its current payables.  Without further outside financial support, Greece will have no choice but to leave the European Union so it can reintroduce its own currency.  The Drachma may not be worth much, but at least they could print as much as they’d like.

In our opinion, a Greek exit is inevitable.  There surely has to be a point where the Germans will tire of bankrolling the Greeks.  It seems that most market participants are now coming to terms with that conclusion as well.  The larger question is the same as it has been for years - what will that mean for other weak European Union members?  This larger question is what’s really driving the current market fears. 

While that question is legitimate, we feel the current market reaction is entirely overblown.  There are significant differences today than there were five years ago.  Most notably, the European banking sector is in much better shape than it was in 2009.  Back then, Greek and other questionable sovereign debt was held throughout European banks and posed a real threat to their capital levels.  Years later, that debt, and Greek debt in particular, is held with the ECB.  The risk to the EU banking system doesn’t exist like it did in the past. 

For this reason, we believe this latest downturn will pass in the coming months.  If that were to be the case, we should see stock prices stabilize at their April levels.  Even then, that would only put the S&P 500 up 2.5-3% (before dividends) for the year.  As modest as those returns are, it would be in keeping with our expectations at the beginning of the year.  At that time, we felt that 2015 would finish with upper single digit returns with much of those gains occurring in the last quarter.

The U.S. stock market has strung together several consecutive years of gains (albeit from very depressed levels) and was in need of a pullback due to the valuations.  This year was likely to be the year earnings would need to catch up to stock prices.  The greatest impediment to that scenario was the strengthening dollar relative to the Euro.  Europe is our second largest export market so a stronger dollar makes our goods more expensive in their currency.  This then negatively translates into many U.S. companies’ earnings.

Depending on the day you’re reading this, to date the U.S. stock markets are largely flat.  Unlike last year, the mid and small cap sector of the stock market has performed better than the S&P 500.  The NASDAQ index has also out-performed large cap stocks.  Still these gains are modest at best. 

One other unknown hanging over the stock market is when will the Fed begin to raise rates?  They have stated that their preference is to start the process sooner than later.  At this point, the consensus is, barring any European contagion, it will be this fall.  Generally rate hikes are bad for the stock market, but this expectation has been built into the market for a while.  Higher rates will also be a needed relief for investors seeking income.  There’s a long way to go before we see anything that looks like normal interest rates, but we need to begin that move very soon.

In conclusion, while the Greek news had a big impact on the past quarter’s performance, ultimately we don’t think it will have led to anything by the end of the year.  Once there is a better understanding of the stronger dollar’s impact on GDP, we’ll probably see the Fed enact their first rate hike since the financial crisis began years ago.