New IRA rollover rules: Help clients take advantage

Here’s something you don’t hear too often: Thank you, IRS.

Yes, thanks to the IRS, advisers can immediately help clients avoid harsh penalties and taxes on late 60-day rollovers from company plans and IRAs.

But beware: There are some rollover mistakes that still cannot be fixed.

This past August, the IRS began allowing these late rollovers by providing the receiving financial institution with what is known as a self-certification. The IRS even provides a model letter clients can use, and, unlike the time-consuming and expensive private letter ruling process, this one is quick and free.

This is a big deal, given that, before this, a PLR was the only way for clients to get relief from penalties and taxes from late rollovers. This year the PLR fee for 60-day rollovers was increased to $10,000, not counting professional fees that could add thousands more to the total cost.

This process was too expensive for most, limiting it to only those with large IRAs, where the cost may have been worth the benefit.

The obvious question is, “Why doesn’t everyone avoid this mess and do direct rollovers?” They should, but they are not always available from plans and IRAs and perhaps some people are impatient and it’s quicker to get the check, instead of waiting for the direct transfer.

Andrew Harrer/Bloomberg News

Also some clients don’t know about the direct transfer option and do 60-day rollovers without consulting an advisor, or they take a check upon the recommendation of employee at the bank or financial institution they are talking to. Advisors should be communicating more proactively with clients to avoid 60-day rollovers.

THE 60-DAY ROLLOVER RULE
The general rule is that, when a client takes a distribution from an IRA or other tax-deferred retirement account, it must be contributed back within 60 days of the receipt of the funds.

If the funds are not rolled over within 60 days, the consequences are serious. The distribution of pre-tax amounts is taxable, plus there is a potential 10% early distribution penalty, and the funds are no longer part of a retirement account.

Even a late Roth IRA rollover is affected. While the distribution may not be taxable, the tax-free Roth shelter can be lost.

This differs from a direct, trustee-to-trustee transfer, which is still the recommended way to transfer retirement funds, whenever possible. This new IRS relief rule is only for late 60-day rollovers where a distribution is paid personally to the account owner or plan participant.

Advisers need to make clear to clients that the new self-certification is not a waiver of the 60-day rule. It allows the late rollover, but the IRS can disallow it in an audit if they determine the client did not qualify under any of the 11 reasons spelled out in the ruling.

In addition, during an IRS examination, an agent can grant a late 60-day rollover waiver. If the IRS previously denied a waiver of the 60-day rollover rule, the client does not qualify for self-certification relief.

11 REASONS
Here are the 11 acceptable reasons the IRS provides for missing the 60-day deadline:

1. An error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates.
2. The distribution, having been made in the form of a check, was misplaced and never cashed.
3. The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan.
4. The taxpayer’s principal residence was severely damaged.
5. A member of the taxpayer’s family died.
6. The taxpayer or a member of the taxpayer’s family was seriously ill.
7. The taxpayer was incarcerated.
8. Restrictions were imposed by a foreign country.
9. A postal error occurred.
10. The distribution was made on account of a levy, and the proceeds of the levy have been returned to the taxpayer.
11. The party making the distribution to which the rollover relates delayed providing information that the receiving plan or IRA required to complete the rollover, despite the taxpayer’s reasonable efforts to obtain the information.
12. The late rollover contribution must be made “as soon as practicable” after the reason or reasons for the late rollover no longer prevent the client from making the rollover contribution.

The IRS will also be updating Form 5498, IRA Contribution Information, to show that a late rollover was accepted. This may be an invitation to audit, so you should ensure clients do the following to protect themselves:

1. Make sure the IRS has not previously denied a waiver of the 60-day rollover rule.
2. Make sure the reason for missing the 60-day deadline was one of the 11 the IRS lists in the ruling.
3. Fill out the self-certification letter and give to the plan administrator for company plans or the IRA custodian, and make sure this will be accepted. The custodians do not have to accept the late rollover, for example, if they have knowledge that the client is not being truthful, or they know they don’t qualify. This self-certification does not have to be filed with the IRS. The late rollover will eventually be reported to them by the IRA custodian on Form 5498.
4. Make sure the late rollover is done as soon as possible.

VALID ROLLOVERS
This new ruling is not an absolute get-out-of jail free card, and advisers should know the limitations, as well as which late rollovers cannot be waived.

Read more: Sample letter to request certification for late rollover contribution

The IRS was careful to include that the rollover must be a valid rollover to qualify for relief. Not all distributions from retirement accounts are eligible to be rolled over, so even if these were rolled over in a timely manner, they are still not valid rollovers and can result in taxes and penalties.

A prime example of an invalid rollover is a violation of the once-per-year IRA rollover rule. The stricter version of this rule has been effective since 2015. The once-per-year rule now applies in aggregate to all IRAs, including SEP IRAs, SIMPLE IRAs and Roth IRAs, rather than separately to each IRA account.

In addition, a non-spouse IRA beneficiary, including a trust beneficiary, can never do a 60-day rollover, so this relief does not apply here either.

It is not crystal clear whether the strategy commonly referred to as a 60-day IRA loan will qualify for relief if the funds are not returned within the 60 days. Advisers should be careful here.

While not specifically stated in the ruling, it appears that using the funds while they are out of the IRA will not qualify for relief. The clue is from one of the listed reasons for late rollovers, where it states that “the distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan.”

The word “remained” seems to imply that the funds were not used.

IN CASE OF DEATH
Another open question is: One of the acceptable reasons the IRS provides for allowing a late rollover is “a member of the taxpayer’s family died,” but what if the client him or herself died?

Numerous PLRs have allowed late rollovers due to the death of the IRA owner or plan participant. While this is not a specifically stated reason in the new ruling, it might pay to use the self-certification here, because the IRS has almost always allowed this, and can still allow this if questioned at an audit.

One drawback is that, even when the IRS has granted waivers in this situation, they have also ruled that there is no designated beneficiary when a new IRA has to be established, as a beneficiary was not named as of the date of death.

This would mean no stretch IRA for a beneficiary, because the beneficiary would have been named by the executor after death. But still, the funds can be rolled over and escape immediate taxation.

Advisers can now start to help clients who, for a variety of valid reasons, did not roll their retirement funds over in time. This is good news, but all of this can, of course, be avoided by using direct transfers instead of 60-day rollovers.