Why do IRA rollover mistakes threaten your retirement savings?

One of the most critical rules to understand when executing an IRA rollover is the 60-day rule. This regulation stipulates that once you receive a distribution from your IRA or retirement plan, you have 60 calendar days to complete the rollover to another eligible retirement account. If you miss this deadline, the entire amount becomes taxable as ordinary income, and you may owe a 10% early withdrawal penalty if you're under age 59½.

The 60-day clock starts ticking from the date you receive the funds, not from when you request the distribution. Weekends and holidays count toward the 60 days, so it's crucial to act promptly. Many investors mistakenly believe they have two months to complete the rollover, but this is not the case – 60 days means exactly that, regardless of how many days are in the intervening months.

To avoid issues with the 60-day rule, consider using a direct transfer instead of an indirect rollover. With a direct transfer, the funds move directly from one financial institution to another without ever passing through your hands. This method eliminates the risk of missing the 60-day window and ensures a smooth, tax-free transfer of your retirement assets.

Another common mistake is violating the once-per-year IRA rollover rule. This regulation limits you to one IRA-to-IRA rollover in any 12-month period, regardless of how many IRAs you own. This rule applies to rollovers between traditional IRAs and between Roth IRAs, but not to conversions from traditional IRAs to Roth IRAs or rollovers between different types of retirement accounts – such as 401(k) to IRA rollovers.

The once-per-year rule is based on a rolling 12-month period, not a calendar year. For example, if you complete an IRA-to-IRA rollover on March 1, 2024, you cannot do another one until March 2, 2025. Violating this rule can result in the amount rolled over being treated as a taxable distribution and potentially subject to the 10% early withdrawal penalty.

To avoid running afoul of this rule, consider using direct transfers instead of rollovers whenever possible. Direct transfers are not subject to the once-per-year limitation, allowing you to move funds between IRAs more frequently if needed. Additionally, keep careful records of any rollovers you perform to ensure you don't inadvertently violate the 12-month waiting period.

Rolling over a 401(k) to an IRA is a common transaction when changing jobs or retiring, but it comes with its own set of rules and potential pitfalls. One key consideration is whether to roll over to a traditional IRA or a Roth IRA, as this decision can have significant tax implications.

If you roll over a traditional 401(k) to a traditional IRA, the transaction is typically tax-free. However, if you choose to roll over to a Roth IRA, you'll need to pay income taxes on the amount converted in the year of the rollover. This can result in a substantial tax bill, so it's essential to carefully consider your current and future tax situation before making this decision.

Another important rule to remember is that you cannot roll over required minimum distributions (RMDs) from a 401(k) to an IRA. If you're age 73 or older (as of 2023), you must take your RMD for the year before rolling over the remaining balance. Failing to do so can result in an excess contribution to your IRA, potentially triggering penalties.

To avoid mistakes when rolling over a 401(k) to an IRA:

• Consider using a direct rollover to avoid the 60-day rule and potential withholding issues.
• Carefully evaluate the tax implications of rolling over to a traditional vs. Roth IRA.
• Ensure you've taken any required minimum distributions before initiating the rollover.
• Review the investment options and fees in your new IRA compared to your 401(k) to make an informed decision.

The consequences of an invalid IRA rollover can be severe and often irreversible. If you fail to complete a rollover within the 60-day window or violate the once-per-year rule, the entire amount of the failed rollover is treated as a taxable distribution. This means you'll owe income taxes on the full amount, and if you're under age 59½, you may also be subject to a 10% early withdrawal penalty.

In addition to the tax consequences, an invalid rollover can result in an excess contribution to your IRA if you've already deposited the funds into a new account. Excess contributions are subject to a 6% penalty tax each year they remain in the account. To correct this, you must remove the excess amount and any earnings attributable to it before your tax filing deadline (including extensions).

The financial impact of these mistakes can be substantial. For example, if you attempt to roll over $100,000 from one IRA to another but miss the 60-day deadline, you could owe $22,000 in federal taxes (assuming a 22% tax bracket) plus a $10,000 early withdrawal penalty if you're under 59½. This $32,000 hit to your retirement savings can significantly impact your long-term financial security.

To avoid these costly consequences:

• Always use direct transfers when possible to eliminate the risk of missing deadlines.
• Keep meticulous records of all IRA transactions, including dates and amounts.
• Consult with a tax professional or financial advisor before initiating complex rollovers.
• If you realize you've made a mistake, act quickly to explore potential remedies, such as requesting a waiver from the IRS for missed deadlines in certain circumstances.

While prevention is the best strategy, there are some limited options for correcting IRA rollover mistakes if you act quickly. The IRS provides relief in certain situations, but these remedies are not guaranteed and often require demonstrating that the error was due to circumstances beyond your control.

If you miss the 60-day rollover deadline, you may be eligible for an automatic waiver if you meet specific criteria, such as an error by the financial institution or a severe illness. In other cases, you can request a private letter ruling from the IRS, but this process can be time-consuming and expensive.

For violations of the once-per-year rule, there is unfortunately no remedy available. The IRS has stated that they will not grant relief for these violations, emphasizing the importance of understanding and following this rule carefully.

If you've made an excess contribution due to a failed rollover, you can correct it by withdrawing the excess amount plus any earnings before your tax filing deadline (including extensions). You'll need to report this correction on your tax return and may owe taxes on the earnings, but you'll avoid the ongoing 6% penalty on excess contributions.

To minimize the risk of needing to correct rollover mistakes:

• Plan rollovers well in advance, allowing ample time to complete the transaction.
• Use direct transfers whenever possible to avoid the 60-day rule entirely.
• Keep a clear record of all IRA transactions and consult it before initiating any rollovers.
• Work with experienced financial professionals who can guide you through the rollover process and help you avoid common pitfalls.

IRA rollovers can be a valuable tool for managing your retirement savings, but they come with significant risks if not executed properly. By understanding the rules surrounding the 60-day window, once-per-year limitation, and specific requirements for different types of rollovers, you can protect your hard-earned retirement assets from costly mistakes. Always consult with a qualified financial professional before making significant changes to your retirement accounts to ensure you're making the best decisions for your long-term financial security and legacy.