Moving Retirement Plan Assets: How To Avoid Mistakes

A large number of taxpayers move their assets between retirement plans and financial institutions on a daily basis. And while financial institutions and financial services providers try to ensure that mistakes do not occur, they sometimes happen anyway. Consequently, you share the responsibility of ensuring that the rollover or transfer you request is permissible under current regulations.

Tutorial: Retirement Planning

When you move your retirement assets from one plan to another, the receiving plan must be eligible to receive the assets. If you move the assets to the wrong type of retirement plan, you lose the tax-deferred status of the moved assets and may also create unintentional tax consequences. (For a summary of the types of plans between which assets can be moved, see Moving Your Retirement Plan Assets?)

Example 1 John withdrew his 401(k) balance of $500,000 and rolled over the amount to his SIMPLE IRA at his local bank. John was not aware that according to regulations he was not allowed to roll over amounts from other retirement plans to his SIMPLE IRA. Two years later, John hired a tax professional who discovered the error when she reviewed John's recent tax returns. Unfortunately, it was too late to correct the error without consequence. But John still had to remove the $500,000 from his SIMPLE IRA and because the amount stayed in his account for two years, he had to pay the IRS an excise tax of $60,000 (6% for each year). In addition, John lost the opportunity to accrue tax-deferred earnings, which would have accumulated had the amount been rolled to his traditional IRA. Had John detected the error within 60 days of receiving the distribution, he could have distributed the amount from his SIMPLE IRA and deposited the amount to his traditional IRA as a rollover.

Example 2 Jane deals with two financial institutions. At the first she has a traditional IRA. At the second she has both a traditional IRA and a regular (non-IRA) savings account. Jane instructs the second financial institution to transfer assets from her IRA to her IRA at the first financial institution. A year later, Jane realizes that the delivering account number she provided was that of her regular non-IRA account. Consequently, the transaction resulted in a regular contribution to the IRA, not a plan-to-plan transfer. Unfortunately, neither financial institution detected the discrepancy and prevent the erroneous transaction. Because Jane already contributed the maximum amount to her IRA, she must remove the funds as a return of excess contribution. If Jane does not correct the error by the applicable deadline she will owe the IRS a 6% penalty on the amount for each year it remains in her IRA. (For more insight, see How To Correct Ineligible IRA Contributions.) Note: If the amount is not more than the IRA contribution limit, and includes only cash, Jane may leave the amount in the IRA and treat it as her regular IRA contribution, providing she did not already contribute to her IRA for the year.  

If you withdraw your IRA assets and roll over the amount within 60 days, the amount is not subject to income tax or the 10% excise tax that applies to distributions that occur before you reach age 59½. This is commonly referred to as a 60-day rollover, and you can use it only once during a 12-month period for each of your IRAs. So, should you roll over more than one distribution during the 12-month period, only the first distribution is considered rollover eligible.

Example 3 Tom, a 45-year-old taxpayer, owns two traditional IRAs. In April 2012, he withdrew $50,000 from IRA No.1 and rolled over the amount to IRA No.2 within 60 days. The transaction is tax- and penalty-free because it was properly rolled over. In January 2013, John withdrew an additional $40,000 from IRA No.1 and rolled the amount over to IRA No.2 within 60 days. The $40,000 is not eligible to be rolled over, because John had already rolled over a distribution from IRA No.1 during the preceding 12 months. John must remove the $40,000 as a return of excess distribution in order to avoid any penalties. Tip: When moving retirement assets between two traditional IRAs or two Roth IRAs, it is recommended that the movement be done as a trustee-to-trustee transfer. There is no limit on the number of trustee-to-trustee transfers that may occur between your IRAs.  

Before moving your retirement assets, check with your financial advisor for assistance in ensuring that the transaction is permissible under current regulations. In addition, check to make sure that funds were transferred to or from the right account, and in the correct order. You may be able to correct errors without penalties if they are detected early.