Individual Retirement Accounts: Protecting the "Right to Rollover"

05/17/2011- Robinson Donovan Case Digest

By Attorney Michael Simolo  Attorney Micheal Simolo

  • The IRS allows taxpayers to withdraw funds from their individual retirement accounts free of tax if the withdrawn funds are "rolled over" into another IRA within 60 days of the withdrawal.
  • Under certain limited circumstances, the IRS will waive the 60 day rollover requirement.  

Individual Retirement Accounts, commonly known as "IRA's", are a common form of tax-advantaged savings vehicle.  Though the form may vary, the basic advantage of an IRA is that it allows the account to grow tax free until the taxpayer reaches age seventy and one-half.  Upon reaching the designated age, the taxpayer must withdraw a "required minimum distribution" every year thereafter and pay income tax on the distribution.  The minimum distribution is calculated based on a life expectancy table published by the IRS.  The taxpayer is of course free to withdraw funds over that amount, but any amount withdrawn will be subject to income tax.


There are numerous statutory restrictions imposed by the Internal Revenue Code on investments in and withdrawals from IRA accounts.  If an investor runs afoul of these restrictions, significant tax penalties can result.  For example, if an IRA investor withdraws funds from the account before reaching the age of fifty-nine and one-half, then, in general, a 10% tax penalty will be incurred.  The taxpayer will need to report the distribution as income in the year in which it was received and will pay income tax on the distribution, plus pay the 10% penalty.

Another restriction applies to the so-called IRA "rollover".  The rollover provisions provide that withdrawals from an IRA, other than required minimum distributions, are not subject to any tax consequence whatsoever if they are "rolled over" into another IRA or similarly situated retirement plan within sixty days of the withdrawal.  A taxpayer could withdraw his or her entire IRA and roll it over into another IRA or qualified retirement account without incurring any tax penalties or income tax.  For example, a rollover allows a taxpayer to move his IRA from one financial manager to another, or for a surviving spouse to roll the IRA of a deceased spouse into his or her own IRA.  Failure to complete the rollover within 60 days, however, will usually result in the full value of the distribution being included in the taxpayer's taxable income for the year of the distribution, together with a 10% penalty for those under fifty-nine and one-half.

The Internal Revenue Code, recognizing the maxim that "what can go wrong, will", has carved out an exception to the rollover exception.  Under the Code, the IRS may waive the 60 day requirement where the failure to grant such a waiver would be "against equity and good conscience".  Several recent private letter rulings from the IRS help demonstrate when "equity and good conscience" may entitle a taxpayer to a waiver of the 60 day requirement.  Here are some fact patterns under which the IRS has waived its 60 day requirement:

  • Where the company managing a taxpayer's IRA made distributions in error to the taxpayer refused to take back the distribution; and the taxpayer eventually (but outside the 60 day requirement) redeposited the funds into a different IRA;
  • Where the taxpayer withdrew funds from his IRA for the purpose of transferring the funds to a "higher yielding IRA" but was advised by "an individual at his Bank" that the rollover needed to be complete within 90 days, not 60.  The taxpayer did not learn that the required period was 60 days until after completing his rollover outside the 60 day period (but within the 90 day period); and
  • Where the taxpayer died twelve days after receiving a distribution that he intended to roll over. 

 The IRS's sympathy for these situations, however, is limited.  In another recent case, a taxpayer withdrew funds from his IRA and lent them to his mother, with the intention that once his mother secured a reverse mortgage, he would be repaid and would rollover the funds.  Though he fully intended to rollover the funds within 60 days, the mother's bank delayed the granting of the reverse mortgage, resulting in the taxpayer missing the 60 day requirement.  Because the bank that caused the delay had nothing to do with the IRA, the IRS denied the taxpayer's request for a waiver of the rollover requirement.

It is worth mentioning that the taxpayers in each of the successful cases kept careful records and were able to document their claims when presenting them to the IRS.  Further, while the resolutions reached in those rulings were favorable to the taxpayer, each of the taxpayers likely incurred significant costs in procuring the ruling.  As the last case demonstrates however, although it is reassuring to know that the IRS may waive at least some of its many IRA requirements, it is always best to comply with the regulations surrounding IRA's and other forms of retirement plans, and to seek advice from a competent professional when any issues or questions arise.

This article is a general summary only and does not constitute legal advice.

 

Michael Simolo is an attorney at Robinson Donovan, P.C.  If you would like further information about estate planning, please contact your RD attorney or Attorney Simolo at (413) 732-2301.