Change text size

Topic: Traditional IRA

IRA Rollover Rules and Taxation

By Bob Palechek, CPA | April 3, 2020

You own your retirement funds.  That grants you some flexibility in what you do with the funds and where you put them.  But with flexibility comes responsibility, and you are responsible for following all of the IRS’s rules.

You may get help from plan custodians, administrators, or bankers, but that does not relieve you of the responsibility of getting it right.  And a word of caution: many actions cannot be undone.

You may decide to move your retirement funds (1) between plan types, (2) to new accounts, or (3) to a new holder or custodian of your assets.  If so, your goal is generally to achieve this without creating a taxable event and, done correctly, that should be achievable.

Our goal is to provide you with that knowledge.  Or to show why you might want to consult with a tax pro before you start.

Transfers versus Rollovers

The transfer process is relatively straightforward.  The rollover process is more complicated.  Let’s look at both.


A transfer is typically done between IRAs.  You let your new IRA know of your wish for it to ‘receive funds’ from another IRA, and you provide all the details of your original IRA.  The new IRA will pull the funds across.  No taxes are withheld, and you receive no funds.  It is a safe and easy way to transfer retirement funds.  You do not need to report a direct transfer on the IRS’s Form 1099-R, so you shouldn’t be alarmed if you don’t receive one.


All movements of funds that do not qualify as transfers are considered rollovers.  And, they are more open to having something go wrong if not handled correctly.

Employer 401(k)-related rollovers

A typical rollover occurs when you reach out to your employer 401(k) plan and request all or a portion of that money.  This may occur through an in-service withdrawal (if the employer plan allows it) or after departing from that employer.

  • If you want to preserve your funds in a retirement account, you will request a rollover and provide the name of the new qualified plan or IRA account.  The original holder of the funds will issue a direct payment to the plan or account electronically, if available, or via check.  No taxes need to be withheld. You will receive a Form 1099-R to use when reporting the rollover on your taxes.  The distribution amount is shown in Box 1, but none of the amount should be taxable, and the code in Box 7 will be a ‘G.’  All is good.
  • If you receive a check to deliver to the new custodian, you will want the check to be payable to the new custodian, and not to you personally.  That way, this will be considered a direct rollover, and no tax withholdings are required.  The same reporting of the Form 1099-R will occur.
  • If you receive the check payable to you, a 20-percent federal withholding is required.  If your goal is a tax-free transaction, you have 60 days from the ‘constructive receipt’ of the check to deposit it into the new qualified plan or IRA account.  (‘Constructive receipt’ is when you have reasonable access to possession of a check.)
  • If you should miss the 60-day window to deposit, the distribution will be taxable to you and may be subject to a 10-percent penalty if you are below age 59½.  There are no exceptions.  If the 60-day window is missed because of cause, the IRS does provide a relief process but only under strict circumstances.  It should not be relied upon if the deadline was accidentally missed or if you changed your mind.

To remedy the situation and to achieve a complete tax-free rollover in these circumstances, you will have to make up the 20-percent withholdings with other funds.  You will be able to recover the 20-percent withholdings when you file your taxes the following year if you are overpaid.

IRA-to-IRA or Roth-to-Roth rollovers

The other typical rollover is from one traditional IRA to another, or from Roth to Roth.  These rollovers can either be direct (where the check is made payable to the new custodian or IRA) or indirect (where the check is made payable to you).  The first option is preferred because the 60-day window rule is not an issue.

  • On indirect rollovers of a traditional IRA, a 10-percent federal withholding rule is standard but not mandatory.  As in the remedy described above, the 10-percent withholdings would have to be made up with other funds to achieve a tax-free rollover.
  • One inconvenience of the indirect rollover of traditional or Roth IRAs is that you are only allowed one rollover per year.  The rule that introduced that limitation in 2015 exempted rollovers from 401(k)s.
  • If you do an indirect rollover, it will generate a Form 1099-R to use when reporting the rollover on your taxes.  Since an indirect rollover is where the check is received by you and payable to you, the Form 1099-R will come with a taxable distribution code on the form.  The code in Box 7 will typically be a ‘1’ or ‘7.’ However, the issuer has no way of knowing your intentions.  It also does not know if you met the 60-day window rule or the once-per-year rule.
  • If you have someone preparing your taxes, make sure to provide them with all the details of your rollovers so you will not get taxed as though you took the money from your plan.

And if you would like help to ensure that you have followed all the rules, make sure to reach out to your tax professional.  It’s always a good idea to make sure your T’s are crossed and your I’s dotted.

Excess IRA Contributions, Part 3: Fixing Them

By Jim Saulnier, CFP | June 21, 2019

Fixing Excess IRA Contributions 

Albert Einstein is said to have said, “We cannot solve our problems with the same thinking we used when we created them.” So, if we managed to create the problem of excess IRA contributions, we might want to involve a knowledgeable advisor when it comes to fixing excess IRA contributions at the least possible cost.

This article does not cover every aspect of fixing excess IRA contributions. However, it will give you an idea of the complexity, the possible penalties and the seriousness of the problem.

You cannot simply remove the amount of excess contributed. There are specific rules you must follow and timelines you must heed.

The best ‘fix’ will depend on when you discover the excess occurred: whether it’s before or after the due date of your individual income tax return (including extensions), or October 15th of the year following the one where you made the excess contribution.

But first, let’s look at two aspects of excess IRA contributions: penalties incurred and any earnings attributed to excess contributions.

Penalties Incurred 

The penalties for making excess IRA contributions can be a serious matter. First, the IRS will apply a 6% penalty every year that an excess contribution remains in the IRA.

Next, the IRS can go back indefinitely to assess the 6% penalty tax, plus penalties on failure to file and failure to pay, plus any applicable interest. Even if you filed your Form 1040 on a timely basis, the relevant Form 5329 [Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts] is considered a separate tax return, so your failure to file it means the tax may be assessed at any time.

In short, there is no statute of limitations on the 6% penalty. Waiting for the IRS to come after you – while hoping to run out the statute of limitations – is not a workable strategy.

Calculating the Net Income Attributable

Part of rectifying the situation requires determining the NIA, or the Net Income Attributable to that excess contribution, following a special IRS formula. You might seek help in calculating the NIA from the custodian of your IRA account or from a competent advisor.

If you hold multiple IRAs when calculating the NIA, you only need to consider the performance of the specific IRA containing the excess IRA contribution.

The calculation is independent of whether the contribution that created the excess was a standalone investment into a new IRA or was added to an already existing IRA. It will reflect the performance of the entire IRA during the period in question. The NIA will be positive or negative, depending on whether the value of the IRA rose or fell. If positive, you may have to remove the NIA amount, in addition to the excess amount contributed.

Fixing an Excess Before October 15

If you fix the error before October 15th of the year after the error occurred, you can avoid penalties by filling out Parts 3 and 4 of Form 5329, signing it and submitting it to the IRS before the deadline.

However, any NIA earnings while the excess is in the account will be taxable as gross income in the year you made the contribution, not in the year you removed it. As a result, if you have already filed for the year, you will have to file an amended return.

Both the excess contribution and the NIA will have to be removed. Be sure the custodian of the account is kept apprised of any withdrawn asset – which is considered a distribution. The custodian will report the corrective distribution on Form 1099-R.

Any withdrawn NIA-based earnings will also be subject to the 10% early withdrawal penalty if you were under 59½ when it happened.

Fixing an Excess After October 15

The rules are somewhat different if you only fix the excess IRA contribution after the filing deadline (plus extensions), or October 15th.

You still must file Form 5329 and pay the 6% penalty on the excess contribution for every year it was in the IRA. However, you remove only the amount of the excess contribution, on which the IRS will likely assess income taxes.

You do not have to remove any NIA-based earnings. They can stay in the account and are never subject to the 6% penalty. They will only be taxed when eventually withdrawn.

An Alternative Solution

You can also opt not to remove the excess contribution when you discover it, but rather carry it forward into future years. The excess will be reduced each year by your allowable IRA contribution amount until the excess is wiped out. This process is automatic and requires no special reporting. The cost to you will be the 6% penalty as long as any excess exists.

Wrapping up, we know mistakes happen. And as explained earlier, in the case of excess IRA contributions they can happen relatively easily. Fixing them, though, requires the right steps in the right order.

While consulting with someone knowledgeable would likely have avoided the mistakes in the first place, it can certainly ensure they are not compounded. Give our team a call so we can review your situation.

Excess IRA Contributions, Part 2: How They Happen

By Jim Saulnier, CFP | June 7, 2019

How Excess IRA Contributions Can Happen

If you simply put the right amount of money each year in the right IRA account and allowed it to grow until time to withdraw funds, managing traditional IRAs would be smooth sailing. However, both life – and the desire to maximize the returns on your retirement funds – create opportunities to stumble over IRS rules and regulations. Following are four of the most common ways excess IRA contributions happen that could result in the payment of taxes and penalties:

1. Failed 60-day rollover

The IRS allows you to move money around tax-advantaged retirement accounts under three different scenarios. Two of them, ‘direct rollover’ and ‘trustee-to-trustee transfer,’ are relatively error-free since you never touch the money. (The funds move institution to institution.)

The higher-risk scenario is the ’60-day rollover.’ A distribution from a traditional IRA gets paid directly to you, and you have 60 calendar days to deposit the funds in another qualified IRA account (traditional, SEP or SIMPLE).

If you exceed 60 days, the transaction will be considered a distribution, and you will have to pay ordinary income taxes on the funds distributed, plus a 10% penalty for early withdrawal if you are below age 59½. (Some waivers do exist.)

Whereas most people are aware that you can only make one 60-day rollover per year, they don’t realize that it is one rollover per 365 days, not per calendar year. It is a common mistake. Say you make a 60-day rollover in late 2019, then another in early 2020, believing you are in the clear since it is a new year. However, because less than a year has transpired between rollovers, the second one may be treated as an excess IRA contribution, with penalties in addition to being fully taxable to you.

2. Missed Roth IRA Conversion Deadline

Just as you can move funds from one traditional IRA to another, you can also move them from a traditional IRA to a Roth IRA. However, it will require ‘conversion.’ Since a Roth IRA is purchased with ‘after-tax’ dollars, you will have to pay the tax on any untaxed amounts being taken from the traditional IRA.

However, before making the conversion, any RMD due on the traditional IRA must first be taken. The conversion will be of the funds left in the account after distribution of any outstanding RMD. If you don’t satisfy the RMD requirement, the RMD portion of the conversion will be deemed an excess Roth IRA contribution, and subject to penalties.

Regardless of how the funds are transferred from the traditional IRA to the Roth IRA, conversions are considered 60-day rollovers. They will be deemed a failed 60-day rollover (with defined penalties) if you miss the deadline for having the funds back in a qualified account.

3. Required Minimum Distribution Rollovers

With tax-advantaged accounts, the IRS gives you the equivalent of tax deferral over the years, but it eventually wants to start collecting some taxes. It does so through Required Minimum Distributions or RMDs, and each year the amount you need to take out will be based on an IRS formula that reflects your remaining life expectancy. RMD’s are taxed as ordinary income in most cases.

With a traditional IRA, you will have to start taking distributions in the tax year you reach age 70½. (The IRS defines that moment as six calendar months after your 70th birthday.)

You can accumulate the RMDs due from multiple accounts of the same type and pay them all out of one account as long as it is also of the same type. However, you cannot withdraw RMD funds for three traditional IRAs from a 401(k) account, for example.

With rollovers, you have to take any RMD due on a traditional IRA before rolling its funds over into another IRA account. What you roll over will be what is left in the IRA after the RMD. The RMD portion will be taxed. The rollover portion will not be taxed, assuming you haven’t done a rollover in the prior 12 months.

If you do roll funds over before you take your RMD, the RMD portion of that rollover will be considered an excess IRA contribution, and you could face penalties.

Your annual deadline for taking an RMD will typically be December 31, but if it is your first RMD you have until April 1 of the year following the one in which you reach age 70½. However, that would mean taking two RMDs in one year: one by April 1 and the next one by December 31. Both distributions would be included in income for that same year.

If you withdraw more than the RMD for one year, you cannot carry forward the excess to any future years. If you withdraw too little – or miss a deadline – you could be subject to a 50% excise tax on the shortfall of what you should have distributed.

4. Non-spouse Inherited IRA Rules

If you inherit a traditional IRA from a deceased spouse as a beneficiary, the IRS offers considerable flexibility in the actions you can take. However, that flexibility does not extend to you if you are a non-spouse.

As a non-spouse, you cannot treat the inherited traditional IRA as your own. For example, you cannot make any contributions to the IRA or roll any amounts into or out of the inherited IRA. The single act of doing so will disqualify the entire inherited IRA and will cause it to be immediately taxable. There is no remedy for this mistake.

Nor can you combine an inherited traditional IRA with a traditional IRA of your own. If you do so, the funds that were moved from the inherited IRA will be considered an excess contribution in your existing IRA and will be subject to penalties. Also, they will be fully taxable as a distribution from the inherited IRA, and the IRS offers no remedy such as undoing the transaction.

Fixing an Excess IRA Contribution

You now know some of the more common areas where taxpayers make mistakes when managing their IRAs, and next, we will show you how to fix excess IRA contributions when they happen. Meanwhile, an easy call to our office can help you avoid them altogether.

Excess IRA Contributions, Part 1: Basic Qualifications

By Jim Saulnier, CFP | May 24, 2019

Excess IRA Contributions: Basic Qualifications

We hear a lot about how important it is to contribute to an IRA. So, ‘how to contribute correctly’ becomes an important topic. Not that it is difficult, but there are some important rules regarding IRA contribution qualifications that you have to follow.

And since you put money into an IRA to allow it to grow in a tax-advantaged environment, you don’t want to break one of the rules and have it cost you money. One of the main ways that could happen is if you make excess contributions.

In this three-part guide on excess IRA contributions, we are going to review (1) the basic qualifications for making valid contributions, (2) some of the more complex situations you will have to navigate and (3) how you can fix accidental excess contributions and avoid costly penalties.

Why would you want to contribute to an IRA?

In a traditional IRA, your contribution may be fully or partially deductible from the amount of income on which you will be taxed this year. Your contribution will be made with ‘pre-tax dollars.’ Because you won’t pay taxes on those funds now, the portion you would have paid in taxes is also allowed to grow until it is withdrawn, or ‘distributed.’ You will pay the tax upon withdrawal, both on original funds and any gains.

When can you take money back out of an IRA?

You can withdraw money from an IRA whenever you want. However, if you are below age 59½ when you do so, you will pay 10% additional tax on the funds, above your applicable tax rate for that year. From age 59½ forward, you will pay just that year’s applicable tax rate. Then, at age 70½, you will start having to take out Required Minimum Distributions, or RMDs, based on an IRS formula. Not doing so may lead to hefty penalties.

How much can you contribute to an IRA?

For 2019, each person can contribute a total of $6,000 (or $7,000 if you are age 50 or older), as long as you have at least that much in ‘qualified income.’ Anything you contribute above your qualified income will be considered an excess contribution. You have to be particularly careful if you contribute to IRAs being held by multiple custodians (such as authorized banks and brokers), as it is your responsibility to monitor the total, and not the custodians’.

How do you define ‘qualified income’ for contributions?

In general, the IRS defines qualified income as wages, salaries, tips, professional fees, and bonuses. It also includes commissions, self-employment income, alimony, and separate maintenance, as well as nontaxable combat pay. However, you cannot consider Social Security, rental income, investment income, dividends, interest or royalties (among others) in your calculations. Using the wrong kind of income to justify contributing to a traditional IRA puts you at risk of making an excess contribution.

How does spousal income figure into IRA contributions?

You may not have any (or enough) qualified income to justify contributing fully to an IRA. However, if your spouse does and if you file a joint tax return, you can use your spouse’s income to qualify. Each spouse will hold a separate IRA, but the total of your combined contributions cannot be larger than the taxable income reported on the return. If it is, you will be facing penalties for excess contributions.

How long can you contribute to an IRA?  

You can only contribute to a traditional IRA until the year in which you turn 70½. Say you turn 70½ in December of 2019. You cannot contribute at all to a traditional IRA in 2019, even if you were still 69 in early 2019. When in the year you contribute is irrelevant. Any contribution you do make will be considered an excess IRA contribution.

What about Roth IRAs, how do they differ from traditional IRAs?

To start, contributions to a Roth IRA are not tax-deductible, so they are made with ‘after-tax dollars.’ As long as you meet the distribution qualifications, funds will not be taxed when withdrawn. (Remember, you already paid tax on the funds). However, because of the tax advantages Roth IRAs offer on gains, the IRS places caps on the income of those allowed to contribute. If your income is higher, you will have made an excess contribution.

Other differences? You can contribute to a Roth IRA regardless of age, that is, even after you reach 70½. You also do not have to start taking distributions at 70½ but can leave funds there for life.

What next?

Now you have the basic guidelines for contributing to an IRA without being penalized for excess contributions. More complex issues will be reviewed next. However, if you would like to make IRA contributions part of a strategic retirement plan, please reach out to our office so we can help.