This Costly IRA Mistake Is Surprisingly Easy to Make

If you’re thinking of doing an IRA-to-IRA rollover this year, there is a costly — and often overlooked — mistake you need to avoid: violating the “once per year” IRA rollover rule.

Never heard of it? We suspect you are not alone. In fact, accidentally violating the rule is “one of the most expensive mistakes a client can make,” write tax experts Robert Bloink and William H. Byrnes in a post at ThinkAdvisor.

Your risk of violating the once-per-year IRA rollover rule is perhaps highest if you have multiple IRAs and would like to consolidate them down to a single IRA. A widow or widower who inherits an IRA from a spouse and wants to roll it into her or his own IRA also might be at risk for violating the rule if that person made an IRA-to-IRA rollover in the recent past.

The IRS essentially defines a “rollover” as withdrawing money or other assets from one retirement account and depositing all or some of it into another retirement account.

The assets you withdraw from an IRA during a rollover are not considered taxable income as long as you move them into another IRA and complete the transfer within 60 days. Many people know this rule.

However, what they might not understand is that you are limited to one such rollover in any 12-month period. If that raises your eyebrow, don’t just take Bloink and Byrnes at their word — the IRS itself says this policy has been in effect since 2015.

According to the IRS:

“Beginning after January 1, 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own…The limit will apply by aggregating all of an individual’s IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit.”

What happens if you perform more than one IRA-to-IRA rollover within a 12-month period? A few things, and none of them is good.

For starters, the entire amount from the second rollover — and any subsequent rollovers that fall within the 12-month period — will be fully taxable.

And it gets worse. According to Bloink and Byrnes:

“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 59½, 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.”

Also, Bloink and Byrnes point out that the limit applies on a 12-month basis, not a calendar-year basis. So, one easy way to get caught violating the rule is to pursue a rollover late in one year (say, in December 2021) and assume that you can do another rollover early in the following year (such as in March 2022).

There are exceptions to the once-per-year IRA rollover rule. According to the IRS, the limit does not apply to:

• Rollovers from traditional IRAs to Roth IRAs (also known as conversions)
• Trustee-to-trustee transfers to another IRA
• IRA-to-plan rollovers — such as from an IRA into a 401(k)
• Plan-to-IRA rollovers — such as from a 401(k) into an IRA
• Plan-to-plan rollovers — such as from one 401(k) to another 401(k)

It is important to emphasize that your ability to transfer funds from one IRA trustee directly to another — such as from Vanguard to Fidelity — remains intact. That is because this type of transfer is not considered to be a rollover.

Bloink and Byrnes conclude their post with what should now be an obvious truth: “The once-per-year IRA rollover rule is complicated.”

So, if you are planning more than one IRA-to-IRA rollover in the coming years and want to arrange things so you don’t violate the IRS rule, consult an expert first. You can find one by stopping by Money Talks News’ Solutions Center and searching for a vetted financial adviser.

You can also discover tips for finding a great accountant in “How to Get the Right Tax Pro at the Right Price.”