IRS Cuts Some Savers a Break on IRA/401(k) Rollovers

Rolling over a 401(k) plan or another qualified retirement plan can potentially trigger a tax penalty if you fail to complete the transaction within the appropriate time frame. Fortunately, the Internal Revenue Service (IRS) is loosening up the rules on rollovers for certain taxpayers who aren’t able to roll their retirement account over quickly enough. (See: Common IRA Rollover Mistakes.)

Ordinarily, you have 60 days to complete a rollover from one retirement plan to another if you elect to receive the funds, rather than having them transferred directly to the new plan's trustee. If you don’t deposit the rolled-over funds into the new account before that time period expires, that money is treated as a regular distribution. 

In that scenario, the rollover proceeds would be considered taxable income. You’d also owe a 10% early withdrawal penalty on the distribution if you’re under age 59½. Going forward, Revenue Procedure 2016-47, which was issued in August, allows eligible taxpayers to qualify for a waiver of the 60-day time limit and avoid paying taxes on some rollovers that take longer. 

Not everyone is eligible to take advantage of the waiver, however. The new rule is designed to benefit people who, because of mitigating circumstances, aren’t able to complete a rollover on time. Here are acceptable-to-the-IRS reasons for missing the cutoff:

  • The financial institution receiving the contribution or making the distribution made an error.
  • You received the distribution as a check, but it was never cashed because it was misplaced.
  • You deposited the money into an account that you mistakenly believed was an eligible retirement plan.
  • Your principal residence was severely damaged.
  • You or a member of your family was seriously ill.
  • There was a death in the family.
  • Restrictions were imposed by a foreign country.
  • You were incarcerated.
  • A postal error occurred.
  • A "levy under § 6331" is also an acceptable reason; get advice from a tax expert if you think this applies to you.

To qualify for the waiver, taxpayers have to provide a self-certification letter to the administrator or trustee of the retirement plan that’s receiving the rollover. This letter needs to briefly explain the reasoning for missing the 60-day window. Taxpayers should keep in mind that they won’t be able to self-certify if they previously requested a waiver of taxes on the distribution and that waiver was denied.

There's one last rule: The contribution must be made "as soon as practicable" after the reasons no longer exist – and within 30 days at the latest. The IRS calls this the "30-day safe harbor."

If you’re planning an indirect rollover from one Individual Retirement Account (IRA) to another, there’s another rule the IRS wants you to remember. Only one such rollover is allowed per year; otherwise, you could trigger serious tax implications. "Year" means a 12-month period after the rollover is made – not the calendar year in which the rollover occurred.

If you want to minimize your tax liability any time you’re shuffling money between retirement accounts, opting for a direct rollover may be the best option. (Read also: Guide to 401(k) and IRA Rollovers.