IRA Indirect Rollover Rule

According to a 2016 study by the Department of Labor1, the median number of years that the average employee between the ages of 55 to 64 had been with the same company was just over 10 years. For the entire working population, that number was only 4.2 years. Needless to say, it is no longer the norm that people work for the same company their entire lives.

With such turnover, and the disappearance of traditional pension plans in favor of employer sponsored plans such as a 401(k), 403(b) and others, the American worker has to now deal with rolling over funds from their retirement plans on a somewhat regular basis.

By way of a news release a few years back, the IRS announced that beginning on January 1, 2015, only one (1) indirect rollover per a 12-month period is permitted without a tax or penalty, regardless of the number of IRA accounts that you may have.

What is an Indirect Rollover?
When an owner takes a withdrawal from a tax-deferred plan and receives the funds personally and returns the funds to an IRA within 60 days. IRC § 408(d)(3)(B)

Sue decides to retire from her job and roll over funds from her 403(b) plan into an IRA. Sue decides that she wants the funds sent to her directly instead of a trustee-to-trustee transfer, and that she will deposit them in the IRA within the next 60 days. If she completes this task properly, then Sue will not face a tax or penalty.

Rollovers NOT Subject to the New Rule

  • Trustee-to-Trustee transfers of like accounts such as traditional IRA to traditional IRA
  • Direct rollovers that go institution to institution such as 401(k) to an IRA
  • Rollovers between qualified plans and IRAs

What We Learned From The Case
Perhaps the most interesting part of this rule comes from how it was derived. It was a result of a court decision in the case of Bobrow vs Commissioner. Since 1994, Publication 590, which is an IRS document, provided guidelines regarding the income tax treatment of distributions from IRAs. The court however contradicted the IRS guidance. In its ruling, the court ruled that the legislative history of the provision regarding indirect rollovers 408(d)(3)(B) did not intend to allow for multiple withdrawals contrary to Publication 590. In his decision, Tax Court Judge Joseph W. Nega said that the IRS published guidelines “is not binding precedent” and that “taxpayers rely on IRS guidance at their own peril.”

There are 3 takeaways from this ruling that are extremely important if you are contemplating transferring funds from retirement accounts. First, understand that there are rules that must be followed to avoid unintended consequences. Second, make sure to work with a qualified professional. Finally, this is a reminder back to civics class that the judicial branch (the courts) interpret laws, while the executive branch (IRS), is responsible for enforcing the laws.

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