By Russell W. Hall, CFP®

Are you planning to roll over an IRA account? As with many things in the world of finance, this generally simple procedure has a few potential pitfalls of which you should be aware. A few years ago, the IRS updated their rules, making rollovers from traditional IRA accounts more restrictive, and it’s easy to make an expensive mistake if you are not careful.

First, let’s clarify that we’re talking about the “60-day rollover rule,” where a distribution is withdrawn from an IRA (including Roth, SEP, or SIMPLE) with the proceeds going directly to the account owner. The funds are then rolled back into another IRA account within a 60-day window, which is called an indirect rollover.

For those rollovers, the IRS rule is now that you can do only one 60-day rollover per year (once in every 12-month period, or every 365 days). The time frame is also specifically 60 days, not 60 business days or a two-month period.

This one-rollover-per-year rule does not apply to every situation. Direct transfers, where an IRA moves directly from one account to another, are exempt. This is also called a “trustee-to-trustee transfer” or “IRA to IRA rollover,” and there is no limitation on the number of those transfers.

We’re not sure why you’d want to go through the trouble, but you can roll over your account between custodians as often as you choose (watch out for those nasty account closure fees, of course).

Transfers to or from other retirement plans [like a 401(k) or 403(b)] and Roth IRA conversions are not included either, as long as the funds don’t pass through the account holder’s hands.

Also exempt are retirement account rollover checks made payable to a custodian and not the account holder, e.g., “Charles Schwab FBO John Smith.” That’s true even if those checks are mailed to the account holder, as long as that person doesn’t cash the check but passes it on to a financial institution. We see many rollovers from big 401(k) companies processed in this manner, so it’s relatively common.

As a side note, if you’re over 70 ½ when you retire and roll over your 401(k), expect that the plan administrator will calculate and process the required minimum distribution (RMD) automatically before the rest of the rollover. This is due to the IRS rule that the first dollars out of the account must fulfill the RMD requirement before anything can roll over.

That rule about first dollars out also applies to indirect IRA rollovers. If you need to take an RMD in a given year, that distribution must be completed first before you can roll over any future distributions. For instance, if your RMD is $10,000 and you take a $7,000 distribution, you cannot roll that $7,000 back into the IRA within 60 days. You must first withdraw all $10,000 before any 60-day rollover can happen. For more information about RMDs, see “Answers About Required Minimum Distributions.”

It’s also important to note that the one 60-day rollover per year applies to all IRAs in aggregate. For example, you could not receive rollover checks for an IRA and a SEP-IRA account and deposit both checks into new accounts within 60 days. One of those deposits would be ineligible and completely taxable income, and it would be subject to a 10% early distribution penalty if you are under age 59 ½. 

Ed Slott, a CPA in New York and an expert on IRA distributions, calls this a “fatal error … it cannot be fixed.” The ineligible deposit would also get hit with a 6% excess IRA contribution penalty if it was not removed in time. That’s a lot of income tax that would be due for what seems like a simple mistake.

In practice, we have seen clients do 60-day rollovers when there is a short-term need for cash, like purchasing a new home before their previous house sells. In the past, it was possible to take separate distributions from multiple IRA accounts, each with its own 60-day window. 

Some would take a distribution from their IRA and Roth IRA, and then deposit the money back within 60 days. The new rule severely limits this practice, and the IRS has been strict about enforcing it.

So how can you avoid running afoul of these rules? The simplest way is to stick to direct transfers since you should be safe as long as you’re moving from trustee to trustee.

We generally try to avoid 60-day rollovers because we’ve seen situations where the client was unable to get the money back to the account in time. In that case, the entire distribution is taxable income and could be subject to an extra 10% penalty if the person is under age 59 ½.

If you must do a 60-day rollover, be very careful with the time frame, and be sure to do only one distribution every 12 months.

If you have specific questions about an IRA rollover and how these rules affect you, our Fullerton financial advisory firm is happy to talk through your situation. Schedule a 15-minute discovery call with a fee-only financial advisor.

Editor's Note: This post was originally published on September, 2017 and has been updated for accuracy and comprehensiveness.