People who take a distribution from a retirement account – whether because they are leaving a job or for other reasons – need to handle the distribution very carefully to stay within IRS rules. The surest way to avoid applicable taxes and penalties on the amount is to roll it over to an eligible retirement account within 60 days of receipt. (You can also convey the money through what's called a direct transfer and avoid the problem by never actually receiving the distribution.)
There are, however, a few exceptions to this rule. Knowing them can help you avoid paying taxes on rollover-eligible distributions that do not satisfy the 60-day rule and ensure continued tax-deferred growth of your retirement assets.
Exception for First-Time Homebuyers
Taxable distributions of up to $10,000 from your IRA are not subject to the 10% additional tax (early-distribution penalty) if the IRA owner or a qualified family member is a first-time homebuyer – and if, within 120 days of receipt, the IRA owner uses the amount to pay for qualifying acquisition or rebuilding costs for his or her own or a qualifying family member’s principal residence. If the amount is not used because of a cancellation or delay in the purchase or construction of the residence, the amount may be rolled over to the IRA within 120 days instead of the usual 60 days.
Automatic Waiver Application
An individual may deliver distributed assets from an IRA or other qualified retirement plan to a financial institution and intend the amount be deposited to his or her retirement account as a rollover contribution. Sometimes, because of an error, the amount is not credited to the retirement account within the 60-day period. Such errors can occur if you maintain multiple accounts with your financial institution, and a representative inadvertently deposits the amount to the wrong account, such as your regular checking account.
To be sure your instructions are followed, check your account statement for accuracy, and contact your financial institution immediately if you detect any errors. If this happens to you, you receive an automatic extension of the 60-day period (under Section 3.03 of Rev Proc 2003-16), providing all of the following requirements are met:
- The assets were delivered to your financial institution within 60 days after you had received the distribution.
- You followed the procedural requirements for rollover contributions that were established by your financial institution.
- The amount was not deposited to your retirement account because of an error made by the financial institution.
- The assets are deposited to your retirement account within one year after you received the distribution.
- The transaction clearly would have been a valid rollover contribution had the financial institution followed your instructions at the time of receipt.
Self-Certification of a Valid Reason for Missing the 60-Day Window
If you do not qualify for an automatic waiver, your life just got easier. As of August 24, 2016, the IRS changed its procedures for those who missed the deadline and don't qualify for an automatic waiver. Under a new regulation called Revenue Procedure 2016-47 you can "self-certify" that you are qualified for a waiver of the 60-day rule for one of the following 11 reasons, as noted by the IRS website:
"(a) an error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates;
(b) the distribution, having been made in the form of a check, was misplaced and never cashed;
(c) the distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan;
(d) the taxpayer’s principal residence was severely damaged;
(e) a member of the taxpayer’s family died;
(f) the taxpayer or a member of the taxpayer’s family was seriously ill;
(g) the taxpayer was incarcerated;
(h) restrictions were imposed by a foreign country;
(i) a postal error occurred;
(j) the distribution was made on account of a levy under § 6331 and the proceeds of the levy have been returned to the taxpayer; or
(k) 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."
Previously, in order to be considered for the waiver, you had to submit an application to the IRS for a private letter ruling (PLR) and pay the applicable fee, which had risen from $500 for rollover amounts under $50,000 to $10,000, regardless of the amount involved.
Ensuring Correct Reporting
If a cancellation or delay in the purchase or construction of a first home is the reason you didn't use the distributed amount within 120 days for first-home costs, you were eligible for the automatic waiver within one year of the distribution, or your application for extension to the IRS was approved, you must report the amount of the exception on your tax return as nontaxable to exclude the amount from your income and avoid the penalty. This is done by including the amount on the applicable line of your tax return.
If you have failed to roll over the amount within the 60-day period and don't qualify for these exceptions, you must include any taxable amount of the distribution as income, and pay the applicable taxes.
The Bottom Line
“The tax code is long, complicated and sometimes very hard to interpret,” says Kevin Michels, CFP®, financial planner for Medicus Wealth Planning in Draper, Utah. Consult with your tax professional for assistance with determining the taxable portion of your distribution and including the amount on your tax return. Your tax or legal professional should also be able to help you with determining your waiver eligibility and the application process.
“A note of caution: Only one ‘60-day rollover’ can be completed every 12 months or the penalties and taxes can be very extreme,” notes David S. Hunter, CFP®, president of Horizons Wealth Management in Asheville, N.C. For more, see Common IRA Rollover Mistakes.