IRA Rule Review #1: The Once-Per-Year Rollover Rule.

I recently met with prospective clients who had the misfortune of breaking the IRA once-per-year rollover rule. There is no way to correct their mistake which, unfortunately, resulted in sever tax consequences for them.

Tax laws permit you to do a tax-free 60-day rollover of a distribution from an IRA. However, the once-per-year rule limits how often you can do this without facing adverse tax consequences.

Remember, a rollover is when you take money out of a retirement account and deposit it into the same or another retirement account. As long as the deposit occurs within 60 days of the distribution, the distribution will not be taxable or be subject to the 10% early distribution penalty if you're younger than 59½. This is the 60-day rollover rule and applies to distributions from retirement accounts.

Under the once-per-year rule, you can only do a 60-day rollover once per year. This rule applies to traditional IRA-to-traditional IRA rollovers and Roth IRA-to-Roth IRA rollovers. It applies to all of your traditional and Roth IRAs combined, not each account separately.

The one year prohibition period begins when you take the first distribution from an IRA that is rolled over into another or the same IRA within 60 days. Thus, the rule prevents you from rolling over a subsequent distribution from an IRA made within one year of the date of a prior distribution that was part of a 60-day rollover.

A couple of examples will illustrate the rule:

1. John, age 48, takes a $10,000 distribution from his traditional IRA on December 15, 2022. He puts the $10,000 back into his IRA on January 1, 2023 (within 60 days). This is a qualified rollover, meaning John won't face taxes or penalties. John takes another distribution from his IRA on November 30, 2023. John can't do a 60-day rollover of that distribution because the it occurred within one year of the first distribution. He'll owe income taxes on the distribution amount and a 10% penalty for being a pre-59½ distribution.

2. Same scenario as before, but this time John takes the second distribution from his IRA on December 24, 2023. Since this distribution occurred more than one year after the first one, John can deposit the funds into the same or another IRA within 60 days without tax consequences.

Breaking the once-per-year rule will lead to income and penalty taxes, and there's no way to fix it. Also, funds deposited into an IRA in violation of the rule will subject you to a 6% excess contribution penalty unless the error is promptly corrected.

Luckily, there are exceptions to the rule. Direct transfers between IRAs and rollovers from employer-sponsored plan accounts to IRAs (and vice versa) are exempt from the once-per-year limit. Also, conversions of funds from a traditional IRA to a Roth IRA are not subject to the rule.

Understanding and following the IRS once-per-year rollover rule helps you manage your retirement savings effectively, avoiding unnecessary taxes and penalties. If you're unsure about your situation, it's wise to consult a knowledgeable tax professional or financial advisor. So give me a call, I can help.