Personal Finance: Details matter when rolling over IRA funds

Personal Finance: Details matter when rolling over IRA funds

July 30th, 2014 Chris Hopkins in Business Diary

Chris Hopkins

Photo by Patrick Smith/Times Free Press.

Since the early days of IRA accounts in 1981, investors have been granted one tax-free rollover per year per IRA account, to allow for changing custodians or even renewing investments within accounts at the same custodian. Thanks to a recent tax court ruling, only one rollover per taxpayer per year is permissible, regardless of how many accounts may exist.

This is a surprising development, and unwitting investors could conceivably find themselves in tax trouble if they run afoul even accidentally of the new strictures.

Although frequently applied incorrectly, the term "rollover" has a specific meaning in the IRS code. A rollover is defined as a distribution from an IRA account (traditional or Roth) that is payable to the account holder and subsequently re-deposited into the same or a different IRA account of identical title within 60 days. This process may be repeated once every 365 days.

The IRS has previously interpreted the statute to apply independently to each IRA account in the taxpayer's name. But in a recent U.S. Tax Court case known as Bobrow v. Commissioner, the court ruled that the once-per-year limit applies per taxpayer regardless of the number of accounts. This makes it especially important to mind the details of any retirement account transactions and how they might be classified.

In most cases, assets moved from one custodian to another are handed off from institution to institution, without receipt by the account owner. This type of direct trustee-to-trustee movement is technically called a transfer and not a rollover. Direct transfers are not taxed and may be conducted without limit in any given year. This is obviously the preferred method.

However, in some cases a direct transfer may not be available or may need to be specifically requested. For example, some company retirement plans may issue checks to plan participants in the event of termination or retirement unless the account holder specifies direct transfer. If this were to happen in two different plans in one year, some of the money could be taxed.

In some cases, bank-held IRAs may actually change account numbers when an asset like a CD matures. Under the old rules, a new CD could be purchased within 60 days in every account every year; no harm, no foul. Under the new interpretation, only one CD per year could be rolled over tax free. Additional certificates could conceivably violate the rule and trigger tax liabilities.

This liability can readily be negated by asking the right questions at the bank. Make sure the institution knows you want a direct transfer at maturity, not a rollover. If you plan to move a maturing retirement account CD to a different bank, be sure both banks know you want a trustee-to-trustee transfer well before the actual maturity date.

The IRS has announced a delay in enforcement until at least 2015 (barring a hard-drive crash), and further clarification or modification of the rule seems likely. But as it now stands, care is warranted beginning next year when moving or renewing IRA investments to avoid nasty tax surprises.

Christopher A. Hopkins, CFA, is vice president at Barnett & Co. Investment Counsel in Chattanooga.