Broken window: Rollover horror stories

When clients withdraw money from an individual re-tirement account or employer retirement plan and want to move those funds to another retirement account, they must roll over those funds within 60 days of the date that they received the distribution from the plan or IRA.

If the rollover isn’t done in time, the distribution is taxable, creating a tax disaster because the amounts involved can be substantial — and in many cases represent a client’s entire life savings. To make matters worse, clients who are under 591/2 and fail to complete rollovers in a timely fashion also are subject to the 10% penalty for early distributions.

The 60-day-rollover requirement is triggered only when account owners take funds from their IRA or plan in a distribution payable to themselves. A trustee-to-trustee transfer (often called a direct transfer or direct rollover) is by far the best way to transfer the funds from one IRA or plan to another because it eliminates many issues, including 60-day-rollover problems.

Individuals who miss the deadline can submit a private-letter- ruling request asking the Internal Revenue Service to grant a waiver of the 60-day-rollover requirement and extend the time to complete the transaction. This isn’t a simple process, though, and is costly and time-consuming, with no guarantee of a favorable outcome.

EXPENSIVE MISTAKES

A recent private-letter-ruling request concerned the taxpayer’s husband’s taking a distribution from his company plan. He had been forced to take this distribution because his previous employer’s plan had a “cash out” provision that mandated the complete distribution of his account upon reaching 65.

After receiving a check for the full amount of his plan balance, he had begun the process of moving the funds to an IRA, but instead, he deposited the funds into a joint account with his wife. He then became ill and died within the 60-day window after the distribution.

His wife tried to complete the rollover to an IRA in her name after his death and requested this ruling to do so. The IRS denied the ruling.

A spousal rollover may be completed only when retirement funds are distributed to a surviving spouse following the death of the IRA owner or plan participant. In this case, the distribution from the plan took place while the plan participant was alive, so the request was denied.

In another case, an 89-year-old was the beneficiary of her husband’s IRA. After his death, she received a distribution from the IRA, but instead of being rolled directly into her own IRA, it was deposited in a non-IRA account.

She died just 12 days after the distribution was made, without having completed the rollover. The executor of her estate asked the IRS to allow the funds to be rolled over so a taxable distribution could be avoided.

The IRS denied the request, stating that there was no evidence to show that the wife truly intended to do a rollover, and added that she could have made a direct rollover when she took the distribution but didn’t.

In yet another case, an IRA owner withdrew funds from her account because its value had declined, and then used a portion of the funds for a down payment on a house. She put the rest in a safe deposit box.

She stated that she intended to do an IRA rollover and thought that she had 90 days instead of 60. The IRS denied her request to waive the 60-day rule, stating that her ignorance of the tax rules caused the problem.

Finally, a taxpayer took a distribution from his IRA and used it as a short-term loan to help his ailing mother with the purchase of a home. Once the home was purchased, his mother was to take out a reverse mortgage, providing, in part, the funds needed to roll the distribution back to an IRA within 60 days, but due to processing delays, the rollover window was missed.

The IRS denied the taxpayer’s request to waive the 60-day rule, and the distribution was taxable. The IRS repeatedly has denied private-letter-ruling requests when IRA funds have been used as short-term loans.

Don’t assume anything or take chances. Confirm that money has been deposited into the correct account within the 60 days and verify that the account is an IRA (or other qualified account).

Better yet, avoid all these problems and advise clients to do direct transfers when taking distributions.

Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott’s Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace. He can be reached at irahelp.com.