The Once-Per-Year IRA Rollover Rule a 59-Year-Old Just Broke by Mistake — and the $94,000 Tax Bill Now on the Way

At some point, you may decide to do an IRA rollover. You may do so to consolidate your savings or for another reason, such as if you don’t like your financial institution’s platform and want to move your money elsewhere.

You’ll often hear that a direct rollover is the “cleanest” way to move funds from one retirement account to another. With a direct rollover, your money is transferred between qualified accounts so that you never receive a check for those funds.

But if a direct rollover isn’t possible, you can instead do an indirect rollover. With an indirect rollover, you get a check for the sum you want to move to a new retirement account. You then have 60 days to deposit those funds into a qualified account to avoid having them treated as a distribution.

If you only make one indirect rollover every 12 months, you may not run into problems provided you follow the 60-day rule and get that money transferred into a new qualified account on time. But making more than one indirect rollover within 12 months could get you into serious financial trouble.

A decision that could come back to haunt you

Bob, a 59-year-old engineer from Illinois, recently learned the hard way that as an IRA owner, you can only make one 60-day indirect rollover per 12-month period.

Now there can be exceptions. But if you don’t qualify for one, doing a second indirect rollover within 12 months could cost you a bundle. That’s what happened to Bob.

With a second indirect rollover, the following could happen:

• Your rollover could be counted as ordinary income and taxed accordingly.
• Your rollover could trigger a 10% early withdrawal penalty if you aren’t yet 59 and 1/2 years old.
• Your rollover could trigger an excess contribution penalty if you attempt to deposit those funds into a retirement account.

All of these things happened to Bob. He did a second indirect IRA rollover within 12 months in the amount of $275,000. That sum got added to his gross income and he faced ordinary income taxes on it. Since his tax-filing status is married filing jointly, he’s in the 24% bracket, and his distribution cost him $66,000.

But Bob is also not yet 59 and 1/2, so he got hit with a 10% penalty on that $275,000 that cost him $27,500. Combined with his $66,000 tax bill, he owes the IRS about $94,000. He also risks a penalty on the excess contribution to add insult to injury. Talk about a nightmare.

It’s important to know the rules

The once-per-year rollover rule is one of the most commonly misunderstood IRA guidelines. Many savers incorrectly believe the limit applies separately to each IRA account they have rather than collectively across all IRAs they own.

Unfortunately, the IRS does not tend to offer much flexibility once the mistake occurs. While there are some exceptions, if you violate this rule, you risk serious financial consequences like Bob did.

Granted, you may not be dealing with the same sum of money. The point, however, is that it’s important to understand when and how you’re allowed to transfer money between retirement accounts.

This doesn’t mean you can only do a single rollover per year, though. Remember, the above rule applies to indirect rollovers, which is another reason why direct rollovers are often the safest option.