Avoiding the Once-Per-Year IRA Rollover Trap – ThinkAdvisor

What You Need to Know

  • Violating this IRS rule is one of the most expensive mistakes a client can make.
  • The rule doesn’t apply to rollovers from a 401(k) account or to Roth IRA conversions.
  • The simplest way to avoid mistakes is to use trustee-to-trustee transfers between financial institutions.

To say that 2020 and 2021 have presented a planning challenge is an understatement. Now, with the most serious dangers of the pandemic receding into the rearview, many clients might be interested in taking steps to consolidate their retirement accounts and simplify their finances.

That can be trickier than many clients anticipate, especially for clients with multiple IRAs. Violating the “once per year” IRA rollover rule is one of the most expensive mistakes a client can make — and, unlike RMD mistakes, can’t simply be corrected or waived.

Because the IRS can’t waive the client’s violation of the once-per-year rule, it’s especially important to pay close attention to avoid falling into the potential traps that can cause the client to violate the rule and incur significant tax consequences. 

What Is the Once-Per-Year IRA Rollover Rule?

Clients can complete nontaxable rollovers between IRAs as long as the funds from the first IRA are deposited into the second IRA within 60 days. However, the client can only do this once in any 12-month period. If the client makes a second rollover within 12 months of the first rollover, the entire amount that was intended for rollover will be deemed distributed in a fully taxable transaction. 

The penalties don’t end there, however. If the client isn’t eligible to withdraw funds from the IRA because he or she hasn’t reached age 59 ½, the client can also be subject to the 10% early withdrawal penalty on top of his or her ordinary income tax rates. The rollover can also trigger the 6% tax on excess IRA contributions if the mistake isn’t corrected on time.

The rule applies to all IRAs — including traditional IRAs and Roth IRAs. It does not apply to rollovers between IRAs and employer-sponsored 401(k) plans. The rule also applies to all types of IRAs, so if the client has a SEP IRA, SIMPLE IRA or Roth IRA, the client is limited to one rollover per year across all types of accounts (Roth conversions do not count as rollovers).

The one IRA-to-IRA rollover per year rule applies regardless of how many IRAs the client has. This represents a change from prior thinking, where many believed that taxpayers with multiple IRAs could complete one tax-free rollover per IRA per year. 

IRA Rollover Traps to Avoid

It’s important to understand, as an initial matter, that the once-per-year rule is not actually a calendar year rule. It applies on a 12-month basis. The client cannot, therefore, complete one rollover late in 2021 and another early in 2022 without penalty.