We often hear the term “rollover” in connection with retirement accounts.
People frequently rollover money from one retirement account to another.
One of the biggest types of rollovers occurs when a person leaves a job, and does a rollover of their 401(k) plan to an IRA (here’s how you do a 401k rollover to a Roth IRA).
But as casually as the word rollover is used, there are actually two types, direct and indirect. And which one you use will be more important this year – and from this point forward – than it is ever been in the past.
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What is an Indirect Rollover?
An indirect rollover is when you transfer money from one retirement trustee to another, but the money passes through your hands in between. For example, an indirect rollover is one in which the funds from your former employer’s 401(k) plan are first sent to you personally, after which you then move over into an IRA account.
Under IRS rules, it is permissible to do this, as long as you complete the transfer within 60 days, from beginning to end. So if one trustee issues your check on March 1, you’ll have to complete the transfer of the funds into the new trustee account no later than April 30.
That will mean that you will have to include the amount of the transfer-turned-distribution as ordinary income on your tax return, which will then also be subject to the 10% early withdrawal penalty tax.
Sometimes an indirect transfer is arranged because the taxpayer doesn’t understand the difference between a direct transfer and an indirect one. Other times it happens because the taxpayer has short-term plans for the money, before completing the transfer to the new trustee.
Up until 2014 you were permitted to do one indirect rollover from each retirement account that you owned. However, in 2014 the Tax Court ruled that you can’t make a non-taxable rollover from one IRA to another if you have already made a rollover from any of your IRAs in the preceding 1-year period, so there’s a change for 2015.
We’ll get to that in a bit…
A Direct Rollover is the Preferred Route when Moving Any Retirement Money
A direct rollover is not only the more common way to move retirement money, but it’s also the safest from a tax standpoint.
A direct rollover is just what the name implies, money leaves one retirement account and goes directly to another. It is a trustee-to-trustee transfer, where the money never touches your hands or your bank account. This is the safest – and therefore preferred – way to move any retirement money.
For tax purposes, the IRS doesn’t even consider a direct rollover to be a rollover at all. As a result, there is no limit to the number of direct rollovers that you can do in a given year, and that won’t change going forward.
Let the Receiving Trustee Do the Legwork!
If you are going to arrange a direct rollover, the easiest way to do it is to simply contact the new trustee. They will request the necessary information to accomplish the transfer, and contact your current trustee to arrange the transfer.
This will save you the trouble of having to contact both trustees, and get more involved in the rollover than you need to be. And the more that is done between the two trustees, the less chance there is to trigger events that might turn your rollover into an unintended distribution, and all the problems that that will bring.
New Updates
Where the IRS formerly permitted you to do one indirect rollover per retirement account, the new rule is that you will be able to do just one indirect rollover per 12 month period.
Got that? Just one.
And not one per year, but one per 12 month period.
That means that if you do one on June 30 of 2020, you won’t be able to do another on January 1, just because we’ve moved into a brand new year. The 12-month rule means that you will not be able to do another indirect rollover until July 1 of 2020. It doesn’t matter if you have 15 retirement accounts. You’ll be permitted only one indirect rollover per 12 month period – that’s it.
It gets worse.
If you do the unthinkable, and arrange a second indirect rollover, not only will the full amount of the transfer be taxable and subject to the 10% early withdrawal penalty tax, but you’ll also have to pay a 6% per year excess contribution tax on the of the transferred amount in the new account for as long as the rollover remains in an IRA.
You can get more information by checking out IRA One-Rollover-Per-Year Rule from the IRS.
A Working Example of an Indirect Rollover Gone Wrong
Let’s say that you were to take $20,000 out of an IRA with Vanguard, and decide that you want to move $10,000 to an existing IRA account with E*TRADE, and $10,000 to a brand new IRA with Betterment. For what ever reason, you have Vanguard send a check for $20,000 directly to you, maybe because you haven’t yet opened up the account with Betterment, so you want to hold the cash for a while, and you know you have 60 days to do it.
But this is where the new one-per-year indirect rollover limit becomes ugly.
You may assume that splitting the money between the E*TRADE account and the soon-to-be-opened Betterment account constitutes a single rollover, since all of the funds in the transfer came out of a single IRA with Vanguard.
The IRS won’t see it that way.
They will consider the transfer of money into E*TRADE and Betterment as representing two separate indirect rollovers. As a result, one of the rollovers – probably E*TRADE – will be considered an allowable rollover, while the second will be regarded as an early distribution. That of course will subject you to including $10,000 as ordinary income in the year the transfer is made, as well as the 10% early withdrawal penalty tax.
And if you go ahead and transfer the money into an IRA account with Betterment anyway, you will then be subject to the 6% excess contribution tax for as long as the rollover money is in an IRA account.
Double whammy!
Now let’s say that you have already taken the $20,000 out of Vanguard before you read this article. So you put $10,000 into the E*TRADE account as planned, but then redeposit the remaining $10,000 back into the Vanguard account to avoid all the tax problems.
We can probably say that if you get into such a situation, the best strategy would be to simply pocket the second $10,000 as non-retirement money. You’d have to pay regular income tax on the distribution, plus the 10% penalty. But you won’t be subject to the 6% excess contributions tax for the rest of your natural life, since the rollover won’t be sitting in an another IRA somewhere.
This is complicated stuff, so if you find yourself in a situation like this, you need to talk to a CPA as soon as possible.
Best Advice: Pretend That the Indirect Rollover Doesn’t Exist!
Given the magnitude of the tax consequences, as well as the lack of options, the best overall strategy is to use the direct rollover method anytime you want to move money between retirement accounts.
Forget that the indirect rollover method even exists. If you try it and make a mistake, things will get ugly in a hurry.
Hi, Jeff,
I requested direct transfers from 3 different IRAs at 3 different institutions in 2021 to consolidate accounts. One of them totally botched it and sent the check to me. I figured no biggie; the other two places sent the checks directly to the new institution FBO to me so while doing the 60-day rollover thing is lousy, I could live with it. I had never done an indirect IRA-IRA rollover before and didn’t plan on any ever again, so I didn’t try to return the funds to them.
But now one of the two places I thought had done it correctly is claiming that instead of a direct transfer, it was a rollover. They sent me a 1099-R, which the IRS says isn’t needed if the funds do not go to the participant. The 1099-R is coded 7G. Does this mean I am in violation of the 1-per-year rule, or am I safe since the check was sent directly to the gaining institution? My tax people just stared at me in disbelief so I’m a little concerned. If I’m going to owe money I want to pay ASAP before even more penalties are incurred.
Thanks!
Did a direct transfer from my Traditional IRA account in Vanguard to a Navy Fed IRA IRA acct by wire. Wire instructions said “IRA Direct Transfer, FBO Ken Mills. ”
Vanguard questioning now if they will code it on the 1099-R the send for 2019 as direct transfer using Letter G in Box 7. This is because they wired the money to Navy Fed. Please advise.
Thanks!
Apparently I did not request a payout or offer any information on my 401k after my termination. It seems a indirect rollover has been done. The check I received has pay to the order of (a trustee name then my name address etc,). At the bottom where authorized signature is,there is no signature. Who signs the check? Also I wanted a cash payout from my 401k. How do I go about changing this or can i cash the check I received and pay the taxes and the penalty?
Hi Tracy – Take it to your bank and see if you can cash it (and yes, you’ll then have to pay the tax and penalty). If the bank says no, you’ll have to contact the pension administrator who issued the check and find out what’s going on.
Jeff; I have a Beneficiary IRA that I pulled $10,000 at the beginning of 2018. Ameriprise did another “automatic” distribution of $11,200 this week. I do not want this money in my bank account, and was told by Ameriprise that I could do an indirect rollover within 60 days to put it back into my IRA. If I did so, would I be paying income tax on the $11,200 regardless?
Hi Hana – Not as long as you complete the rollover within 60 days. But if they’ve withheld taxes on the distribution(s) you may not have sufficient money to rollover the entire amount, and that part could be taxable. For example, if the distribution was $10,000 and they withheld $2,000 for taxes, you may have only $8,000 to rollover, unless you supplement the rollover with other funds. Otherwise the $2,000 not rolled over into the new account will be taxable.
Hi Jeff – I have 2 traditional pre-tax IRA’s that I am thinking of combining into I contribution to another IRA with a mutual fund. One IRA is a bank CD that is maturing in early June, 2018 and the other is a brokerage account with a brokerage firm that will require me to request the distribution. If the proceeds from both IRA cash-outs are sent to me and I cut a check for the proceeds to the recipient mutual fund within 60 days will I have met the IRS rule of one indirect rollover within 360 days? Also, if the brokerage IRA has fees deducted so I receive the net proceeds can I add back the fees deducted (without tax consequences) when I send the check to the recipient mutual fund? Thanks.
Ken
Hi Ken – As I interpret the one ira rollover per year rule you’ll be safer if you do a direct trustee-to-trustee rollover of the two IRAs into one. There’s no limit on those. As to making up the exit fees out of pocket, that might be construed as an additional contribution, which may or may not be allowed in your situation. Check with your tax preparer as well as all three trustees to make sure you go about this the right way.
I did 3 indirect rollover in 2016 into 1 account as my agent suggested …(now I know that was a big mistake) of course 2/3 1099R, they coded 1. Im thinking to just take all money out. Is this the best solution?
Hi Sam – You’re question is very specific and carries tax complications/implications. For that reason I’m going to refer you to your CPA. Only someone who knows your actual tax situation should address this kind of question. What I will offer is that if you “just take all the money out” you WILL have taxes and probably penalties. That’s why you need to talk to a CPA.
I am over 59 1/2. I received a pension buyout mid December 2016 and now I want to move a portion into my 401K where I work, now (Feb. 2017) within the 60 day timeline. Does the different years make this something I cannot do?
Hi Clayton – Nope, as long as you’re within the 60 day window you should be OK.
I want to move my one IRA from bank A to Bank B. Total value, about $60,000. I have not made a roll over in the past 14 years. Should I ask Bank A holding the IRA to send a check to bank B , and designate the IRA to my account?
Hi Bob – Or you can have them do a wire transfer. Yes that’s the best way to effect the transfer. It removes any possibility of creating an accidental tax liability.
What do you do when you get a 1099R coded 1 pursuant to an indirect rollover?
Hi Mark – Code 1 means “Early distribution, no known exception (in most cases, under age 59½). Translated, that means that unless you rolled over the distribution within 60 of receipt of the funds, you will have to include the distribution on your tax return. And you will almost certainly have to pay a 10% early withdrawal penalty. You can check this list to see if you qualify for an exception to the penalty, but you will still have to pay ordinary income tax on the distribution (if it wasn’t rolled over).
Follow-up on this situation where you get a 1099-R with a “1” code for the distribution, but you DID roll over into another IRA in less than 60 days. How do you handle when doing taxes? Also, on the 1099-R, it shows no federal withholding, but there is state withholding. What do I do about that? Many thanks for your assistance and expertise.
Hi David – It should be reported on IRS Form 5329, then carried thru to page one of your 1040 (on a tax software package it will flow there automatically). If you did do the rollover, there will be no tax due, and you should be entitled to a refund of the state tax withheld.