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Have you thought about rolling your traditional IRAs from one financial institution to another? Maybe you're looking for higher returns, more investment selections or better service. If you roll over your traditional IRA, there are some common mistakes you must avoid. “IRA rules can be tricky and some have even changed over the years so you need to be careful, otherwise you could pay income tax and penalties,” says Dan Stewart, CFA®, president, Revere Asset Management, Inc., in Dallas, Texas.

In this article, we'll give you an overview of IRA rollover rules and help you avoid breaking them. (Do you know when you're going to retire? It might not be as soon as you think. Read 10 Signs You Are Not OK to Retire.)

TUTORIAL: Traditional IRAs

The 60-Day Rule

After you receive the funds from your IRA, you have 60 days to complete the rollover to another IRA. “That’s 60 days, not two months. I’ve seen mistakes happen,” says Marguerita M. Cheng, CFP®, CEO, Blue Ocean Global Wealth, Gaithersburg, Md. If you do not complete the rollover within the time allowed – or do not receive a waiver, or extension, of the 60-day period from the Internal Revenue Service (IRS) – the amount will be treated as ordinary income in the IRS's eyes. That means you must include the amount as income on your tax return, where any taxable amounts will be taxed at your current, ordinary income tax rate. Plus, if you did not reach age 59½ when the distribution occurred, you'll face a 10% penalty on the withdrawal. (For more on waivers of the 60-day period, see the article Exceptions to the 60-Day Retirement Account Rollover Rule.)

One-Year Waiting Rule

Within one year, after you distribute assets from your IRA and roll over any part of that amount, you cannot make another tax-free rollover of any IRA. This law changed due to a 2014 Tax Court decision.

Previously, the one-year rule only applied to making additional rollovers from the same IRA to another (or the same) IRA. Here's how it used to work: Imagine that you have two IRAs – IRA-1 and IRA-2 – and you make a tax-free rollover from IRA-1 into a new IRA (IRA-3). Within one year of the distribution from IRA-1, you cannot make another tax-free rollover from IRA-1 or from IRA-3 into another IRA. However, you could roll funds out of IRA-2 into any other IRA, because you did not roll money into or out of that account within the previous year.

Under the new rules, you can't roll funds out of IRA-2 either, until the one-year period has passed. “The downside to this is some banks may charge to issue a check to another bank of custodian when you are moving your IRA. Often, banks considered each CD an IRA, so this type of charge could substantially reduce your earnings and almost force you to stay with that bank,” says Morris Armstrong, EA, owner of Armstrong Financial Strategies in Cheshire, Conn.

The once-a-year limit on IRA-to-IRA rollovers does not apply to eligible rollover distributions from an employer plan. Therefore, you can roll over more than one distribution from the same qualified plan, 403(b) or 457(b) account within a year. (Note: This one-year limit also does not apply to rollovers from Traditional IRAs to Roth IRAs, i.e. Roth conversions.)

RMDs Not Eligible for Rollover

You are allowed to make tax-free rollovers from your IRAs at any age, but if you are 70½ or older, you cannot roll over your annual required minimum distribution (RMD) because it would be considered an excess contribution. (To read more, see An Introduction to Correcting Ineligible IRA Contributions, Tax Treatment of Ineligible IRA Rollovers and How to Correct Ineligible (Excess) IRA Contributions.)

If you are required to take an RMD each year, be sure to remove the current year’s RMD amount from your IRA before implementing the rollover. (See Strategic Ways to Distribute Your RMD for more information.)

Same Property Rule

Your rollover, from one IRA or to another IRA, must consist of the same property. This means that you cannot take cash distributions from your IRA, purchase other assets with the cash and then roll over those assets into a new (or the same) IRA. Should this occur, the IRS would consider the cash distribution from the IRA as ordinary income. Here is a hypothetical example of how someone might violate the same property rule:

An entrepreneur, aged 57, has decided to roll over her IRA from one financial institution to another. However, she wants to use her IRA assets to purchase shares of a certain company's stock. She takes a portion of the funds she received from her IRA, buys the shares and places the remaining cash in a new IRA. Then, she deposits the shares of the stock she had purchased into the same IRA to receive tax-deferred treatment.

The IRS would deem the portion of the distribution used to purchase the stock as ordinary income; therefore, the entrepreneur would owe taxes at her current, ordinary income tax rate on any taxable portion of the stocks that were rolled over. Furthermore, because she is younger than 59½, the IRS would assess a 10% penalty on any taxable portion of the amount used to purchase the stocks.

Caution: When Not to Use a Rollover

If you are simply moving your IRA from one financial institution to another and you do not need to use the funds, then you should consider using the transfer method, instead of a rollover. A transfer is non-reportable and can be done an unlimited number of times during any period. A rollover leaves room for errors, including missing the 60-day deadline and losing the check, and you are limited to the once-per-12-month rule, discussed earlier.

“A transfer removes the withdrawal process of the rollover, which ensures that the assets go directly to their end account and investors remove the risk associated with the 60-day rule,” says Mark Hebner, founder and president of Index Fund Advisors, Inc., in Irvine, Calif., and author of “The 12-Step Recovery Program for Active Investors.”

“In my opinion, a direct transfer is the most optimal solution to move funds from one IRA to another,” says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.

Additional Points

You can roll over funds from any of your own traditional IRAs, but you can also roll over funds to your traditional IRA from the following retirement plans:

Note that if rollover eligible amounts from qualified plans, 403(b) plans or governmental 457 plans are paid to you instead of processed as a direct rollover to an eligible retirement plan, the payor must withhold 20% of the amount distributed to you. Of course, you will receive credit for the taxes that were withheld. However, if you decide to roll over the total distribution, you will need to make up the 20%, out of pocket.

If you want to avoid the withholding and the associated reporting requirements, a direct rollover is the method that should be used to effectuate your rollover from your qualified plan, 403(b) plan or governmental 457 plan account. A direct rollover is reportable, but not taxable. Plus, there is no 60-day window to worry about. Be sure to check with your plan administrator and IRA custodian regarding their documentation and operational requirements for processing a direct rollover on your behalf.

You might be able to move funds in the other direction, too. That is, you may be able to take a distribution from your IRA, and then roll it into a qualified plan. Note, however, that your employer is not required to accept such rollovers, so check with your plan's administrator before you distribute the assets from your IRA. Further, certain amounts, such as nontaxable amounts and RMDs, cannot be rolled from an IRA to a qualified plan.

The Bottom Line

To continue learning about rollovers, see How After-Tax Rollovers Affect Your IRA, Tips for Moving Retirement Plan Assets and Guide to 401(k) and IRA Rollovers.

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