2015 IRA Rule Change
A White Paper from Terwedo Financial Services, LLC
T
TERWEDO
FINANCIAL SERVICES, LLC
Overview
Ever since IRAs themselves existed, there was a rule that allowed IRA distributions to be rolled over within 60 days to avoid taxation. This could be used to facilitate a transfer, fix a distribution mistake, or even as a “temporary loan” so long as repayment was made within 60 days. To prevent abuse, particularly in the case of using these distributions as 60-day loans, Congress enacted a rule that limits these rollovers to being done only once every 12 months. However, this has historically applied on an IRA-to-IRA basis so that an investor was only prevented from rolling over each of their IRAs, separately, within a 12 month period.
Taking effect in 2015, the IRS has declared that this rule will no longer apply this rule on an IRA-to-IRA basis. Instead, it will apply on an aggregation basis and an IRA rollover by an investor will prevent that investor from exercising any other IRA rollovers for a period of 365 days, beginning on the date the distribution was made. However, there is also a special transition rule that will still allow old 2014 rollovers to cause a 1 year waiting period only for the IRA accounts involved in the rollover and not for the IRA accounts as an aggregate.
This rule change does not apply to trustee-to-trustee transfers, which is when a client takes an IRA distribution as a check made out to an investment institution and their distribution is deposited directly to that institution. Those may still be done on an unlimited basis.
Reason for the Change
When an investor withdraws funds from their IRA, the withdrawal becomes taxable as ordinary income. If an investor younger than 59½ withdraws from their IRA, they get hit with an additional 10% early withdrawal penalty. However, sometimes investors aren’t withdrawing with the intent to spend the money; sometimes they withdraw with the intent to transfer to a new account. Sometimes, they’re even mistakenly withdrawn. To prevent unnecessary tax penalties for these indirect IRA transfers and withdrawal mistakes, Congress allowed under IRC Section 409(d)(3) for an IRA distribution to be treated as a “rollover” so long as it is either repaid or contributed to a new account within 60 days. The purpose of the withdrawal didn’t matter, only the repayment or transfer.
Originally, there weren’t rules that limited IRA rollovers to only be allowed once every year. If an investor wanted to use their IRA distribution as a personal loan with a virtually unlimited repayment period, they could so long as they had the necessary funds and they repaid each distribution within 60 days.
“Unlimited” Personal Loan Strategy
Day 1 Day 59 Day 118 Day 177
...
$10,000
Distribution Distribution$10,000 Distribution$10,000 Distribution$10,000
Repay Repay
Repay
59 Days 59 Days 59 Days
To prevent this, Congress enacted the rule that a rollover could only occur once every year per IRA account under IRC Section 408(d)(3)(B). Otherwise, taxes would apply to each distribution taken after the first in that 1-year period.
Unfortunately this didn’t stop another loophole from being abused. In Bobrow vs. Commissioner, taxpayer Bobrow realized that he could still create what were essentially 60+ day loans from his IRA accounts simply by borrowing from IRA #1, paying IRA #1 off with IRA #2, paying IRA #2 off with his wife’s IRA, and then finally paying off his wife’s IRA from out-of-pocket funds. The IRS’ attention was finally drawn to this when Bobrow paid his Wife’s IRA off in 61 days instead of the required 60.
61 Days
Day 1 Day 54 Day 109 Day 170
$65,064 Distribution From IRA #1 53 Days 55 Days $65,064 Distribution From IRA #2 $65,064 Distribution From Wife $40,000 Out of Pocket
Bobrow Strategy
Repay IRA #1 Repay IRA #2 Repay Wife IRA
Even though there weren’t any rules against paying one IRA distribution off with another, Tax Court ruled that since all the IRAs involved in the process were aggregated together for income tax purposes, they should be subject to the once-per-year rule as an aggregate. Thus, Tax Court ruled that a distribution from any IRA that an investor owns creates a blackout period for all of their other IRAs, regardless of whether or not they are involved in a transaction chain similar to Bobrow’s.
The New Rollover Rule
Following Tax Court’s Bobrow decision, the IRS issued Announcement 2014-15, stating that it would support the Tax Court’s ruling and implement the 1-year blackout period rule as an aggregate. Thus, beginning in 2015, an investor who takes an indirect distribution from any of their IRAs will have to wait 365 days from the date of the distribution before taking another if they want to avoid taxation.
IRS Announcement 2014-32 clarifies how to apply these new rules, particularly expanding on how to transition a 2014 IRA distribution whose 1-year period extends into 2015:
A distribution that occurs on/after January 1st of 2015 and is rolled over will trigger the 1-year waiting period for all IRAs. (This is a standard application of the new rules.)
A distribution that occurred in 2014 will continue to only trigger the 1-year waiting period for the IRAs actually involved in the rollover, and will not trigger a waiting period for any/all other IRAs on an aggregated basis.
By 2016, all IRA rollovers will be subject to the new aggregated rules for determining the 1-year waiting period.
In this same announcement, the IRS clarified that certain types of rollovers do not trigger a 1-year waiting period and are also not restricted from being exercised during a blackout period caused by another IRA. These rollovers are:
Conversion from a traditional IRA to a Roth IRA
Trustee-to-trustee transfer (under the existing Revenue Ruling 78-408)
Rollover to or from a qualified plan (e.g., rolling over from a 401(k) to an IRA, or from an IRA back to a 401(k))
What This Means
For most investors, this rule won’t change how they take their IRA distributions. Although investors could technically still use their IRAs as a 60-day “personal loan,” not many investors were using the sequential-rollover “extended loan” strategy anyway. The key takeaway is that trustee-to-trustee rollovers are the best option to use when available and that if investors are planning on taking indirect distributions at any time, they should plan for it ahead of time as they may need a more careful IRA distribution strategy in order to avoid any potential tax burdens.
Contact Information
Terwedo Financial Services, LLC
100 2nd Avenue South, Suite 300
Edmonds, WA 98020
www.tfsadvisors.com
(425) 776-0446
Disclosures
This information is not intended to be and should not be treated as legal or tax advice. Readers should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. All information is the most current data available at the time of publication. It is based on sources deemed reliable, but no warranty or guarantee is made at to its accuracy or completeness. Securities and advisory services offered through FSC SECURITIES CORPORATION. Member FINRA/SIPC. Terwedo Financial Services, LLC is not affiliated with FSC Securities Corporation and is not a registered broker-dealer or registered investment
advisor. The views expressed are not necessarily the opinion of FSC Securities Corporation.
