To date, IRS has issued hundreds of favorable Private Letter Rulings waiving the 60- day rollover rule and allowing more time to complete the rollover. IRS is also increasingly denying some rulings when there was no intent to do a rollover, for example when the IRA owner withdrew money from the IRA for other purposes (not to roll the funds back over), when the funds were used during the 60 days, and when the taxpayer could have done a rollover but didn’t (the control test).
The general rule is that when you take a distribution from an IRA (or other tax-deferred retirement account) payable to you that you intend to roll over, it must be contributed back to an IRA (or other tax-deferred retirement plan) within 60 days. Up through 2001, this was a rigid rule with few exceptions. If the funds were not rolled over within 60days, the distribution was taxable. The 10% penalty would also apply if the IRA owner was younger than 59½.
Rollover vs. Trustee-to-Trustee (Direct) Transfer
A rollover is when an account owner takes funds from her IRA or plan in a distribution payable to herself and contributes those funds to the same or another IRA or plan. A trustee-to-trustee transfer (often called a direct transfer or direct rollover) is when the account owner never receives the IRA or plan funds. They are transferred directly from one financial institution to another without her ever touching the money. That is by far the best way to transfer the funds from one IRA or plan to another. The direct transfer eliminates all of the rollover problems and tax rules you’ll read about here.
Trustee-to-Trustee Transfers (Direct Transfers)
The rollover rules do not apply to direct transfers. With direct transfers, there is no 60- day rule and no once-per-year rollover limit. The account owner can do an unlimited amount of trustee-to-trustee transfers within a year. Direct transfers are also exempt from the 20% mandatory withholding rule. The 20% mandatory withholding rule only applies to eligible rollover distributions from company plans and NOT to IRA distributions. The direct transfer removes virtually all of the problems associated with rollovers. Do the direct transfer when you move a client’s IRA money.
Rollover Terminology Problems
One of the problems with rollovers is the terminology. It seems that whenever IRA or plan money is moved from one IRA or plan to another, we call it a rollover, even if it isin fact a direct, trustee-to-trustee transfer. Even above, we said that a trustee-to-trustee transfer is sometimes referred to as a “direct rollover.” Given the definition of a rollover as something that is not a direct transfer, then how could anyone possibly use the term “direct rollover?” That’s tax-speak, and we agree it’s confusing.
For our discussion here, we won’t use that term. We will stick with either direct transfer or trustee-to-trustee transfer, and when we are referring to taking a distribution and contributing those funds to the same or another IRA or plan, we will use the term “rollover” because that’s what a rollover is. Also, to make this discussion easier to digest, we will just use the term “IRA” (rather than plan or IRA) since the same rules generally apply to distributions from plans. In cases where the rules are different for plan distributions, we will point that out.
Tax-Free IRA Rollovers
The point of a rollover is that when you move the money, it is supposed to be tax-free. But a rollover is only tax-free if the distribution is an eligible rollover distribution and account owners adhere to the following two main rollover rules: the 60-day rule and, for IRA to IRA or Roth to Roth rollovers, the once-per-year rollover rule.
Clients have only 60 days from the date you receive the funds from the IRA to contribute them to the same or another IRA or plan. Until 2002, this was a rigid and unforgiving rule, and mistakes were costly.