By Todd Holden, Financial Advisor                        

There are two fatal errors in regard to IRAs that cannot be fixed. Once these errors are committed, the funds can never be placed back in IRA accounts.  Both errors have to do with IRA rollovers and are explained below.

Inheriting a qualified retirement plan (TSP, 401(k), etc.) or IRA

When someone inherits retirement funds from a loved one’s retirement plan or IRA, they have the option to put this money into an inherited IRA. However, this must be done correctly. The money needs to move directly from the existing retirement account to the inherited IRA. The check must be made out to the custodian of the inherited IRA. The check cannot come from the estate, and it cannot be made out to the beneficiary. 

Unfortunately, I recently witnessed a real-life example of this fatal error. Someone walked into my office with a check from his father’s estate. The executor told him that these funds originated at dad’s retirement plan so he could use them to open an inherited IRA. Supposedly, the executor’s accountant and financial advisor provided this advice. They were wrong. The moment this money left dad’s retirement plan and was paid to the estate, the beneficiaries lost the option of putting it into their respective inherited IRAs. The full amount was a taxable distribution to the estate.

When inheriting a retirement plan or IRA, please see your financial advisor prior to claiming the money.

The One-Rollover-Per-Year Rule

This is one of the most misunderstood rules involving IRAs because of the different ways to transfer money between IRAs and retirement accounts. Part of this confusion stems from the fact that there are three ways to move retirement money, and two of them present no problem. All three methods are described below.

Direct Rollover — This is when the participant instructs their qualified retirement plan (401(k), TSP, etc.) to roll money to their IRA. In this case, the plan makes the check out to the IRA. For example, if Jane Smith were moving her TSP or 401(k) to Northwest Federal Credit Union, the check would be made out to NWFCU FBO Jane Smith IRA. (FBO means “For Benefit Of”). These present no problem. If Jane participates in ten different plans from ten different employers, she can move all ten to her IRA through direct rollovers. The check can be sent to the owner, but it has to be made out to the institution/custodian.

Trustee-to-Trustee Transfers — This is when someone wants to move one IRA to another IRA. If John Jones has 6 IRAs and wants to consolidate them with one institution, he can accomplish this using trustee-to-trustee transfers. He instructs the financial institutions to transfer his IRAs directly to the financial institution of his choice and the checks are made out to the institution, not him. Like direct rollovers, there is no limit to the number of trustee-to-trustee transfers John can make.

Rollovers — This is when an IRA holder wants to take money out of their IRA and replace it within a 60-day period. These can be problematic as this rule is often misunderstood. An IRA owner has the right to take money out of an IRA once per year and replace or “roll it back over” within 60 days. Here are the common beliefs that lead to fatal errors:

1. Thinking it is a calendar year.  It is not a calendar year, but a 12-month period. If an IRA owner took money out of their IRA in December 2021 with plans to re-deposit it within 60 days, they cannot do another rollover until December 2022. January does not begin a new year for these purposes.
2. Believing that it is one rollover per account. Many IRA owners have several IRA accounts. The rule is not one per account.  It is a once per 12-month rule. If the account owner withdraws $10,000 from one IRA in January and $50,000 from a different IRA in February, the $50,000 cannot be rolled back into an IRA, and tax consequences apply.
3. Believing it is one per Roth IRA and one per Traditional IRA. It is not. The rule is one IRA rollover per year. Full stop.

In short, the safest way to move money between retirement accounts is by having checks from the retirement plan or IRA made out to the new institution for the benefit of the IRA owner. Plain “rollovers” as described above should be avoided and, if necessary, approached with caution.